We pay a lot of taxes in Australia. ABS data shows the average income earner pays $ 21,246 in income tax alone.
While taxes are important, you don’t want your annual donation to the ATO to be greater than it needs to be.
Because tax rules are complex, it is easy to make mistakes. One of the biggest tax mistakes I see is one that’s hidden beneath the surface. It often goes unnoticed for years, but when discovered it can cost you tens or hundreds of thousands, if not millions.
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This mistake is not a tax planning before investing.
It happens because when most people invest, they focus on choosing a good investment and don’t realize that this is only half the battle …
While your headline ROI is important, it isn’t the most important thing. Instead, you should focus on the true “profit” or return on your investment after paying the tax. There is always one major difference between the two.
Here I am going to cover the top areas to think about so that you can maximize your profits while investing.
Make the most of the difference between high and low tax rates
One of the things that can help increase your after-tax return is capitalizing on the difference between higher and lower tax rates between taxpayers.
This can work for couples investing together or anyone using other “tax authorities” such as a trust or investment company.
One way to make up for the difference in tax rates is for one person in a couple to have a higher tax rate than the other.
This often happens when a couple is starting a family and taking time off from work, but it can also happen when part of a couple wants to start a business, change careers, or plan longer trips.
An example of using lower tax rates
Take a couple who both earn the median income of $ 89,128 in Australia who just had their first child, with the mother taking nine months off work. That would mean the mother’s annual income would be $ 35,852 – $ 22,282 for the three months worked in the year + $ 13,570 in state-paid parental leave.
For someone earning up to $ 45,000, the marginal tax rate is 19 percent, which means you’ll pay 19 cents extra in tax for every additional dollar of income you earn.
Let’s say the mom and dad have a stock portfolio that pays them a dividend yield of $ 5,000 annually. If those shares are held on their behalf, the dividend income of $ 5,000 would need to be included on their tax returns. Then the dividend of $ 950 would have to be taxed at a marginal tax rate of 19 percent.
If the shares were held in his name instead, he would have to pay $ 1,625 in tax based on his income and the marginal tax rate of 32.5 percent.
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Dad’s investment tax of $ 1,625 translates into an after-tax refund of $ 3,375. Mom’s $ 950 tax bill implies an after-tax return of $ 4,050.
The difference between the two is $ 675, which when expressed as a percentage, the mother’s return on investment is a whopping 20 percent higher than the father’s. And as your income and investments grow over time, the tax savings will continue to increase.
When you invest in real estate, you see hundreds of thousands of dollars (or more) grow over time. That means finding a way to sell the property strategically (and realize the taxable profit) in a year that one person in a couple has a lower taxable income and a lower tax rate can save large tax dollars.
A warning at this point – solid planning before investing is essential to reap the full benefits as the difference in marginal tax rates for different individuals and businesses often changes over time.
You can also take advantage of higher tax rates
If an investment property is negative, you can get tax deductible mortgage interest and other property expenses. The higher your tax rate, the more tax deduction you will receive and the more tax you will save.
This creates the opportunity for a person with a higher tax rate to benefit more from the tax deductions of a negatively facing property.
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On the other hand, however, you need to be aware that if you sell the property while you still have a high tax rate, you will have to pay more tax on the capital gains on the property.
This shows that there is no one-size-fits-all strategy, but you can also see that using the rules to your advantage can make a huge difference in the amount of “profit” you will get on your after-tax investment.
But there is another dimension that you should consider if you want to structure your investments as best as possible for you.
Trusts and investment companies
Another method that gives you even more control over the tax results of your investments is through the use of tax authorities such as trusts and investment companies.
Trusts give you the freedom to share your taxable income and capital gains among multiple taxpayers. This can save you a ton of taxes as you can change who you send taxable investment income to every year.
Then each year you can choose who you want to distribute taxable income and gains to based on what gives you the best after-tax investment return.
Again, be aware that there are some tradeoffs and drawbacks in setting up trusts and other tax authorities. Setup costs, running costs on your tax returns, and buying real estate can involve more complicated tradeoffs like different property tax and mortgage interest rates.
Change is difficult
Note that transferring investments from one taxpayer to another (including a trust or company) is not easy as it is considered a transfer of ownership. The transfer of ownership will generally be treated as if your investment had been sold.
This means that tax is payable on every profit and when you transfer ownership of a property you will have to pay stamp duty again – a total disaster.
There may be other costs such as B. Tax preparation costs and legal fees that further affect the post-tax return of your investment.
This means that it’s important to make your tax planning decisions right from the start, as it’s complicated (and expensive) to change things after you’ve started investing.
Ultimately, you need to make sure that the tax benefit you get from using a trust outweighs the cost of these tradeoffs.
But given the amount of taxes you can save, there is the potential for tens of thousands of benefits per year that far exceed the set-up and running costs.
Using the right entities (at the right time) is a serious decision and should not be made without knowing the rules. It can be difficult to figure all of this out on your own. So if you are thinking about using trusts etc, don’t be afraid to hire a good professional to help you.
To make sure you’re getting the right advice, look for someone with a proven track record of working with people like you who does this type of work on a regular basis so you can be sure they can deliver for you.
There is no right or wrong answer or course of action when it comes to your investment tax planning, there is only what is right for you. But you should know that it is important and will be a huge factor in your investment results.
The key to getting things right for you is planning your investment strategy today and how your money and lifestyle will play out over time. In this way, you can optimize your tax structure today and in the future.
They will be able to choose great investments and structure them the right way to give you a great after-tax return.
Ben Nash is a financial expert commentator, podcaster, financial advisor and founder of Pivot Wealth, author of the Amazon bestseller “Get Unstuck: Your Guide to Create a Life Not Limited by Money”.
Disclaimer: The information contained in this article is general in nature and does not take into account your personal goals, financial situation, or needs. Therefore, you should check that the information is appropriate to your circumstances before acting and seek professional advice from a financial professional if necessary.