Reducing your tax bill is an important investment strategy as it increases your disposable income to invest which increases the net return on your investments and ultimately your wealth creation.
Three strategies for reducing tax include:
1. Investing for growth
Investment returns are made up of both income and growth. Income is paid to you on a regular basis and included in your annual tax return whereas growth is tax when you sell the investment. This deferral of tax is an important wealth creation strategy and can make capital growth investments tax effective.
In addition, where an asset is held for more than 12 months before selling it you are entitled to a 50% discount. This means that if you are on the highest marginal tax rate of 48.5% your effective tax rate on the capital gain is only 24.25%. This compares favourably to the tax on income which is at your marginal tax rate of up to 48.5%
With this in mind, you can structure your investment portfolio to include investments with high capital growth rather than high income distributions. Of course, the tax advantages need to be balanced against other factors such as the overall return from investment and income needs.
2. Utilising Franking Credits
Franking credits can make investing in Australian Shares a tax effective strategy. Franking credits prevent shareholders being taxed twice on dividends as they provide a rebate equal to the tax the company has already paid on their profits.
For example, if you received $2,000 of fully franked dividends you would receive a franking credit of $857. You would then pay tax on the dividend and the franking credit, then claim the amount of the franking credit as a rebate.
If you were on a marginal tax rate of 48.5% the tax payable on the dividend is as follows:
a) Calculate tax payable on dividend plus franking credit $2,857 x 48.5% = $1,385
b) Reduce tax payable by the amount of franking credit $1,385 - $857 = $528
In this example you would pay tax at only 26.4% instead of your marginal tax rate of 48.5%.
If you are on a lower marginal tax rate the franking credits are just as valuable as you are able to receive a refund from the tax office for any excess amount.
3. Income Splitting
Income splitting is a very effective strategy for couples. It takes advantage of two sets of marginal tax rates and is particularly effective where one partner is on a lower marginal tax rate than the other.
Income splitting is where you allocate ownership of investments to the lower income earners name to take advantage of the lower marginal tax rates.
Contact Us for more information and to discuss the most suitable solution for your unique situation.
Disclaimer - The information contained on this website is given in good faith and has been prepared from information believed to be accurate and reliable. This information is of a general nature only. Mortgage One and its related entities, nor any of their employees, officers or directors gives any warranty of accuracy or reliability nor accepts any responsibility arising in any other way including by reason of negligence for errors or omissions herein. All assumptions and examples are based on the continuance of present laws and Mortgage One’s interpretation of them. Mortgage One does not undertake to notify recipients of changes in the law or its interpretation. This guide is not designed to be a substitute for specific financial or investment advice or recommendations and should not be relied upon as such. Please contact us for advice on your specific needs
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