Turning the tax system to your benefit
Key Points
- Use the dysfunctional tax system to your advantage
- For the right person, simple tweaks can generate thousands of dollars benefit
- Be sure to account for all benefits and costs
The background
The Australian tax system is a mess. The Government taxes with one hand and redistributes with the other, in the form of handouts and rebates. But, like all complex systems, it can be made to work to your advantage.
Unfortunately, the approach we’re about to highlight requires flexibility. If you’re on a fixed monthly salary, you haven’t got a lot of that.
The good news is, whilst we’ve based our case study on the family tax benefit and the second highest marginal tax bracket, the principle works in a wide range of circumstances and incomes. Even if you get no benefit now, you may in the future.
So, how do you get the tax system working for you?
There is an implicit assumption in its design that the income in a particular year represents a person’s wealth. Marginal tax rates are applied on an annual basis and ‘means testing’ for benefits is typically based on a particular year’s income (not average income over a period, nor total assets).
The key to ‘beating the system’ is a mild amount of income volatility, without being pushed into a higher tax bracket. The principle works best where ‘average income’ sits just above key thresholds.
Let’s use the Family Tax Benefit Part A (FTB) to explain.
Case study – family tax benefit
The FTB is a family assistance payment based on family income and number of children.
Table 1 sets out the maximum income level a family can have before the base rate of FTB starts phasing out. Table 2 shows the income levels at which it cuts out completely.
For financial year: 2012–2013 | Number of children of 13–15 years or secondary students of 16–19 years | |||
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Number of children aged 0–12 years | 0 | 1 | 2 | 3 |
0 | $69 496 | $91 177 | n/a | |
1 | $62 853 | $84 534 | n/a | n/a |
2 | $77 891 | $99 572 | n/a | n/a |
3 | $92 929 | n/a | n/a | n/a |
Note: Income limits are indicative only, please contact us for a more accurate assessment based on your circumstances. Income limits will be higher if you are eligible for Rent Assistance. Children aged 16 or more who have completed Year 12 are eligible for the base rate only. | ||||
Source: http://www.humanservices.gov.au/customer/enablers/centrelink/family-tax-benefit-part-a-part-b/ftb-a-income-test |
These are the annual income limits at which Family Tax Benefit Part A including the supplement stops. | ||||
---|---|---|---|---|
For financial year: 2012-2013 | Number of children of 13–15 years or secondary students of 16–19 years | |||
Number of children aged 0–12 years | 0 | 1 | 2 | 3 |
0 | $101 458 | $112 603 | $146 530 | |
1 | $101 458 | $112 396 | $139 887 | $173 813 |
2 | $112 396 | $133 244 | $167 170 | $201 097 |
3 | $126 601 | $160 527 | $194 454 | $228 381 |
Note: Income limits are indicative only, please contact us for a more accurate assessment based on your circumstances. Income limit is higher if families are eligible for Multiple Birth Allowance. Families with income approaching these amounts may elect to be paid the Family Tax Benefit at a lower rate or at the end of the income year to reduce or avoid overpayment. Different income limits apply to families with children aged 16-21 who are not secondary students. | ||||
Source: http://www.humanservices.gov.au/customer/enablers/centrelink/family-tax-benefit-part-a-part-b/ftb-a-eligibility |
A family with a 13, 10 and 8 year old, earning $99,000, receives roughly $6,600 (base payment of $1,400 per child, supplement just over $700 per child and large family payment of $300 total).
On the other hand, the same family earning $134,000 would receive nothing, despite paying an additional $13,475 in tax.
So earning $95,000 one year and $175,000 the next (or vice versa) means you’ll receive the FTB every second year rather than missing out completely in both years. Because the top marginal tax rate only applies at income levels of $180,000 and above, there’s no extra tax to pay either (more on this later).
There are other benefits, like a higher private health insurance rebate and lower Medicare levy surcharge, although it may cost you in the subsequent year.
Let’s now look at how this might work in practice.
Increasing income volatility
Regular salary earners will find the strategy difficult to execute. But if your employer offers a salary sacrifice arrangement (SSA) you might be able to delay or accelerate your earnings. Even a simple switch of salary timing might give a one-off benefit.
For instance, a person earning $105,000 per annum would shift almost $9,000 between income years simply by changing the timing of their salary from the 15th of the month, to the 1st of the subsequent month.
If you’re planning some unpaid leave it’s worth paying close attention to the timing of it. You might find that the benefit of having it fall in the right year helps fund your holiday.
But you’re more likely to benefit from a ‘volatility strategy’ if you’re earning passive income or running your own business. A business owner, or contractor, has much greater control over the timing of their invoices and payments of expenses. Similarly, a family using a discretionary trust can manage distributions so that benefits are maximised.
In some cases it might be worth prepaying interest, or other expenses, in order to bring down taxable income. But note our comments below on the ‘adjusted taxable income’ calculations. If an expense simply increases a negative gearing deduction it probably won’t make any difference.
Other possibilities
The FTB is one of many ‘means tested’ items. Others include super co-contributions, super ‘surcharge’ (over $300,000), baby bonus, parental leave pay, medical expenses rebate, private health insurance rebate, Medicare levy surcharge and senior Australians and pensioners tax offset (SAPTO). One-off measures like solar subsidies can also be means tested.
Volatile income can also come in handy for Pay As You Go (PAYG) quarterly instalments (paid by business owners and passive income recipients), since they are based on the lower of last year’s income and your estimate for this year.
This feature is not much use if your income is always the same. But it is handy if you can estimate your income every second year to make sure the instalments are always calculated on the lower number, especially if you are borrowing at business loan interest rates to pay them.
Potential pitfalls
Pitfalls to be aware of include:
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Using the right ‘income’. Many benefits are based on the concept of ‘adjusted taxable income’ rather than the taxable income shown on your tax return. So in assessing your eligibility for a particular benefit, use the right income number (there can be slight differences from benefit to benefit).
FTB is based on ‘Adjusted taxable income’ as defined in the Tax Act. This starts with taxable income and adds on fringe benefits, tax-free pensions, foreign income, super contributions and negative gearing losses.
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Marginal tax rates. Avoid increasing your overall tax by pushing yourself into a new marginal tax bracket, or at least make sure you take this into account.
For instance, earning $50,000 this year and $220,000 next year might qualify you for a lot of benefits and avoid lots of surcharges, but you’ll pay more tax than if you earned, say, $90,000 one year and $180,000 the next. In the first case, $40,000 of the income earned in the second year is going to get taxed at 46.5% (instead of 38.5%), adding an extra $3,200 to the overall tax bill.
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Offsetting costs. More than usual, the net result will depend on your personal situation. For instance, issuing an invoice just prior to 30 June might qualify you for the FTB next year but reduce your private health insurance rebate this year. You need to do your sums and make sure the wins outweigh the losses.
- Don’t leave it too late. This isn’t a year-end strategy. Sitting down with your accountant after, or even just before, 30 June is too late.
A final point on this strategy: This is raised as something to talk to your accountant or lawyer about, and only implemented on their advice. We are not licensed to offer personal tax advice.
In a nutshell
Given appropriate circumstances, you may be able to pick up several thousand dollars with very little effort. Even if you can’t execute it now, remember the principle. There might come a time when you get the opportunity to use it.