There are a number of ways to avoid tax in Australia. Some of them legal, some not-so.
Most legal ways of avoiding tax involve you spending money and claiming a tax deduction for spending that money.
However, I’m going to show you two ways to avoid tax without spending a cent.
Now, we must be careful with the term avoid tax, because tax avoidance is illegal in Australia
You should also not attempt to evade tax. There are significant penalties in Australia for evading tax.
The preferred term when employing strategies to avoid tax is tax planning.
It is important that your attempts to minimise tax are not considered tax avoidance schemes.
Here are the two legal ways avoid paying certain taxes.
1. Superannuation Contributions
There are two types of contributions that can be made to superannuation. These are Concessional (deductible) Contributions and Non-Concessional (after-tax) Contributions.
Non-Concessional Contributions do not help us avoid tax. Well, not directly anyway.
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Concessional Contributions on the other hand essentially provide you with a tax deduction equal to the amount contributed. This reduces your income tax payable.
A Concessional Contribution, intended on reducing your income tax liabilities, can be made in one of the following forms:
– Salary Sacrifice
– Personal Concessional Contributions
Contributing to superannuation ensures that your money remains yours.
Notice how you have received a tax deduction yet not spent a cent?
Contributions tax equal to 15% of the contribution amount will be payable on Concessional Contributions.
However, provided your personal marginal tax rate is greater than 15%, you’re ahead. Unless you are a high-income earner whereby you will pay up to 30%.
Lower income earners will actually receive a refund of contributions tax.
The maximum amount that can be contributed to superannuation as a concessional contribution is $25,000 per financial year.
In saying this, more can be contributed under the carry forward unused concessional contributions provisions by making catch-up contributions.
Below is a working example on the benefits of Concessional Contributions.
Let’s assume Sammy runs a coffee shop in Sydney’s North-West and earns $100,000 p.a. (after business expenses). In the 2018/2019 financial year, he would pay income tax of approximately $26,000, providing him with an after-tax amount of $74,000. If Sammy was to make a $25,000 personal Concessional Contribution to superannuation, his taxable income would reduce to $75,000 and he would pay income tax of approximately $17,000. Contributions tax of 15%, $3,750 would also be payable, resulting in a total tax liability of $20,750 and an after-tax amount of $79,250. This equates to an overall benefit of $5,250 in one year!
Of course, Sammy would need to ensure that he has enough personal net income to cover his living expenses, because any amount contributed to superannuation is only accessible once he reaches a condition of release.
For an employee, the strategy would be the same, but instead of making a personal Concessional Contribution, the employee would arrange to salary sacrifice into superannuation.
However, employees are now also able to make personal concessional contributions.
You can use this calculator to figure out how much you can salary sacrifice as an employee.
You must always consider any SG Levy contributions, as these count towards your Concessional Contribution cap and, if you are over age 65 and wish to contribute, you will need to satisfy the Superannuation Work Test.
2. Commencing an Income Stream
This is a way of minimising tax that not a lot of people take into account when putting in place retirement strategies. The savings can be significant for those with large account balances.
For this strategy to work for you, you need to have the ability to access your superannuation savings in full, by having met the superannuation definition of retirement.
There are two main phases of superannuation. Accumulation phase and Pension phase.
To understand how commencing an income stream can avoid tax, you must realise that your superannuation balance is invested.
Regardless of where you hold your superannuation, it is invested in something.
Bank accounts and Term Deposits are an investments that earn interest.
Managed funds pay distributions and can receive capital gains.
Shares pay dividends and can receive capital gains.
Property pays rent and can receive capital gains.
If your superannuation is in Accumulation Phase or a TTR Pension, all the earnings noted above within your account will be taxed at up to 15%.
For example, if your superannuation balance is $1,000,000 and you receive term deposit interest of 4% ($40,000 p.a.), $6,000 in tax will be payable.
If your balance is invested in growth orientated assets such as shares, property, etc. potential capital gains tax (CGT) would be added to this.
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If your superannuation is in Pension phase (except TTR Pension), all the earnings are received completely tax free.
The most common form of Pension phase where earnings are received tax free is when you start an account based pension.
Therefore, by converting your balance to Pension phase, using the example above, you would not be required to pay the $6,000 tax (or any CGT for that matter).
If commencing an income stream sounds appealing for this reason, there a couple of things you need to consider.
Firstly, commencing an income stream will require you to personally receive at lest the minimum income payments, calculated based on your age and account balance.
This will reduce your superannuation balance and may cause a build up in your personal bank accounts if the income is not needed to assist with covering living expenses.
Secondly, if you are under age 60, part of the income you receive may be assessable and taxable at your marginal tax rate, together with any other earnings.
This personal income tax may reduce the benefit of the earnings taxed saved by having your super in Pension phase.
It is essential that you discuss these types of strategies with an adviser and/or tax accountant prior to implementation to ensure it is suited to your circumstances and that you are not entering into a tax avoidance scheme.
