8 Tax Loopholes, Trump’s tax losses, and thoughts on progressive taxation
Welcome to Finance & Fury! Today we’re talking about increasing your net income …and the way to do that is reducing tax.
So, in today’s episode we’ll run through why we pay tax, where it goes and I’ll break down all of those dirty little “loopholes” that you’re hearing about, how the super wealthy tax dodge every single year, how they pay no tax…well, guess what! you’re all entitled to do the exact same thing if you’re in a similar position. So, to take us into it, Mr. Fury…
Enough is enough! I’ve had it with my personal finances being all over the damn place! Everybody strap in…It’s time for Finance & Fury.
Before jumping into all the amazing tax dodges, I want to talk about monopoly again because there’s a part of that that I really, really, enjoy and it’s the fact that every single turn being forced to pay other players based around how many properties you have, is purely chance. Imagine that this specific card in monopoly where you draw it, and every home that you own, you have to pay other players twenty-five dollars for that. Well, imagine that it was guaranteed in monopoly every single turn rather than just based around picking up one random card, I worked up that from this card you’re paying around 20% of tax, where the average cost of a house in the game is around $125 – so that ranges from $50 to $200. And if you’re paying $25 on that average, it’s 20% of tax and it’s actually a really rare event to actually get that card because you’re more likely to land in jail.
Everyone’s played Monopoly I’m sure. Imagined that this was a guaranteed outcome every single turn, how would you play? Would you go hard trying to get as many properties as you can, accumulate as many homes on them, or would you sit back and wait for your payments from other players? And taxes (beyond being a certainty compared with death) really, it’s money that you pay to the government to spend, which in a lot of cases does just go to other players. The sources of tax in Australia you’ve got your income tax (which is based around marginal tax rates on what individuals earn) and that can range from 0% to 47% with the Medicare levy. That’s also paid on capital gains tax and then you’ve got other taxes like sales tax (which is the GST on all goods and services produced), you’ve got state taxes as well, such as payroll, stamp duty tax, and at the federal level as well you’ve got company tax rates. So why do we pay tax? Well you go to jail if you don’t. But beyond that it goes to help run the country with all the operations and services that the government provides. In the latest budget it was estimated that a spend of $464 billion’s anticipated for the financial year. The tax revenue for the year was $433 billion. So, there’s around a $31 billion or so deficit there. Of that spend of $464 billion around 16% of that goes to healthcare, 7% goes to education, 4% goes back to paying interest on debt that’s accumulated, because if there’s a shortfall in spending (such as that $31 billion in that previous example) the funds are borrowed and then that interest has to be repaid as well.
And that comes from our taxes. But when you go to the overall spending picture 35% is spent on transfer payments to other people. That’s a form of social welfare where it’s actually decreased from just shy of around 40% over the past two years down to 35%, so, it’s a good step in the right direction. However, it’s still $430 million every day and the Australian tax policy, it’s designed to be what’s called “progressive” where the higher that you earn in assessable income, the more tax you have to pay at a %age. And there’s a massive debate between politicians and economists over the role of tax policy in affecting the economy, where it can help mitigate or exacerbate wealth inequality.
And, it also has effects on economic growth. And it comes back to the question of the “progressive” policy designed to be fair, but does it create fairness and equality?
I looked up the definitions. The definition for fair is treating people equally without favoritism or discrimination. The definition for equality is the state of being equal especially in rights, status, and opportunity. And everything’s equal when there’s a uniform application or effect without discrimination on any grounds. Based on that definition it sounds like it’s talking about equality of opportunity, where everyone has the same opportunity, while not being in the same position, but we’re all granted the same rights and the same ability to do what others are as well.
What the progressive policy is focusing on is equality of outcome, which is a massive difference to an equality of opportunity. Where the equality of outcome simply means that the more that someone else has, it has to be taken away to give to someone else to have, so everyone can have the same outcome.
And unfortunately, with that policy of equality of outcome, the more equality is actually pushed for, the less equality is actually provided to people when you take the dictionary definitions (where it’s privileging some people over others – if you earn a high income you’re less privileged).
And it’s measured in Australia by a thing called the Gini coefficient (well, it’s actually measured worldwide by the Gini coefficient) and it’s a number between 0 to 1. If you have a number of zero in a country that’s got this thing called the Gini coefficient, it means that everyone’s equal, everyone’s earning the exact same amount regardless of how much they work, it’s just completely everyone’s on the same, say $10,000 per annum. If it’s a Gini coefficient of 1, it means that one person or just a couple have all the wealth and income in the economy. In Australia our Gini coefficient, before taxes and transfers, is about 0.47 and after tax and transfers it goes down to about 0.33 or so.
So, 0.33 is actually a very equal Gene coefficient when you compare it to most other nations. It ranges all the way up to around .62 for South Africa. But again, after transfer payments it comes down to around 0.45.
And when we’re looking at the definition of fair, again, in Australia today who’s doing their fair share? Going through the numbers …people who are of the working age of 18 to 65, it can be broken down into ten lots of 10%. And looking at those numbers, the top 10% of taxpayers pick up 52% of the income tax bill. The next 10% pick up 19%, then the next 10% pick up 13%.
So, the fair share there of tax distributions comes from 30% of people who are working age between 18 and 65. That 30% picks up 84% of the bill. And if you earn $120,000 per annum, or $500,000, or however much – if you think about tax as something you don’t get to keep, technically then you’re working for someone else. Where if you’re earning $120,000 per annum, if your average working year is 240 days, at 48 weeks, five days per week, you’re working around 70 days of that 240 for something else. And if you earn more (say $500,000) you’re working around 100 days of every year of your 240 days for something else – where your money is just going away. And the definition of slavery is working for someone else with no choice, and I’m a bit torn, where the fairness model here doesn’t seem that fair.
There is an article from The Australian that was talking about the government budget and the figures, but here it’s actually just focusing on the government itself and what the government costs in running. The ATO, the individuals responsible for collecting the money, that costs $3.5 billion each year. And they employ 20,000 staff to collect the tax revenue. That’s $163,000 per employee that it costs (that’s not what they get paid, it’s just simply what it cost to run per employee).
To give an example, in the U.S. the IRS (their tax division of, I guess you’d call them the American ATO) you’ve got one bureaucrat for every 2,000 working age people to collect tax. Here, we have one in 500. Moving down the list, the Department of Social Services (the individuals responsible for the transfer payments) they spend $5.5 billion every year just on administration costs. And breaking that down to number employees, it’s an average cost of $160,000 per employee. Federal Department of Health, 4,500 employees costing $222,000 each. The Department of Foreign Affairs, 7,000 employees costing a whopping $240,000 dollars each (I guess it’s fairly expensive to go on overseas holidays every year!).
When you break down the fact that all of these costs are not actually producing anything, it’s been going into a system to try to transfer the payments. And the total bill for the government running itself (just on costs) is just shy of $60 billion. So, it comes to about 16% of our revenue is just going into the system of running it.
And the big problem with higher taxes is that it’s never actually been proven to lift productivity, or enhance prosperity, where every dollar that’s taken out of your pocket is one less that you have to spend. And if you think every dollar that’s taken out of your pocket, straightaway 16% gone on collecting the revenue and redistributing it, well that’s a pretty awful loss when you’re giving a dollar. And if you’re investing, you wouldn’t want to invest or give a dollar, just to lose 16%.
And there’s always the guise of a conversation on tax reforms, really just being a discussion for tax hikes because over time the message of reliance is increased to the point where it’s simply funding the government’s own growth. It hasn’t been a measurable increase in products or services that the population gets for this increase of tax.
When you compare it to times in history, a big fan of ancient Rome where the average tax rate was 1% to 3%. And 3% was a big outlier in the peak of the empire, which was just in major war times. And if you weren’t a citizen you didn’t have to pay tax, it’s only if you’re a citizen you paid your tax, if you weren’t a citizen you didn’t have to because you didn’t get too many rights if you’re a non-citizen in Rome. What happened to society and just kids helping parents out? Oh, wait… ok you don’t have much money left to pay tax so it’s fairly hard. And now we’re in a position of a lot of our money going to a system that’s meant to take care of people, when if we had more money we could take care of each other.
So, remember, it’s up to you. Now, what can you do for your situation? Because, rather than a ‘reliance message’, getting an ‘independence message’ is really the first step when thinking about reducing your tax. And it’s all about financial independence after all and that comes with the independence message. Love him or hate him Kerry Packer has a fantastic quote about minimising tax when he got dragged in front of the Senate inquiry about the print media. His quote, when asked about minimising tax was. “I’m not evading tax in any way shape or form. Now, of course, I’m minimising my tax… and if anyone in this country doesn’t minimise their tax, they want their heads read, because as a government I can tell you you’re not spending it that well that we should be donating extra”.
So, what can you do to reduce your tax? Simple. All the secrets of the rich are here. You can either just earn less – so, stop working – and you won’t pay much in tax. Or if you don’t want that option, we’ll go through 8 ways to actually legally minimise your tax. And that’s by reducing what you’re assessed on. So, rather than just not earning an income you can earn an income, just try to reduce the assessable amount… and one way is the old ‘negative gearing’. Everyone hears about negative gearing, it’s and simply spending more on investment than what you earn.
If you borrow to invest, say borrow home equity and buy some shares, the interest payments there, if they’re higher than the income that you generate from those shares. Say you buy $100,000 worth of some mining shares that don’t pay much income, maybe 3% of dividend yields, compared to interest payments of 4.5% we’ve got a negatively geared investment because you’re putting money into that, and the tax you get back is only as good as your marginal tax rate. And same with property – if you’re paying interest on property and you’ve got ongoing cost management, for every dollar that you’re net losing on that investment, you get to claim the marginal tax rate back. So, for a property if you’re earning an income of $20,000 in rent, but it’s costing $30,000 per annum, and you’re on $100,000, well you’re only getting 39 cents back for every dollar that you spend on that investment. So, that’s negative gearing and unfortunately, it’s not the best for a cash flow position because it actually reduces your after-tax cash flow quite a bit. Even after the tax deduction’s given back.
The second easy tax dodge is ‘deductions’. Similar to the negative gearing example, any investment costs that you have are claimable as tax deductions as long as they’re going towards some asset that’s generating an income.
Other deductions are work-related expenses. If you’ve got some, even education, to improve your current role or job, then you can claim that generally as work-related expenses either through just operating or as educational purposes.
Another great way, is give to charity. If you give money to charity that’s a complete deduction against your assessable income. Another great way, the third way, is buying shares with franking credits. Franking credits are the tax offset on dividend income. When you buy a share that has a fully franked dividend against it, you’re essentially getting back the tax that the company’s paid at the company level to avoid double taxation. If you get a fully franked dividend though, the franking credit actually gets added to your assessable income.
So, an example of that – if you have, say 1,000 Commonwealth Bank shares, each Commonwealth Bank share pays $4.30. Of that, you get $4,300 of dividend. So, I’ve got your 1,000 Commonwealth Bank shares each paying $4.30, you get $4,300 per annum. Attached to this is franking credits of around $1,843. What you get taxed on is the dividend, plus the franking credit. If you’re earning $100,000 again, the total tax that you’ll have to pay is adding those two together so it comes to around $6,143 you’re going to be assessed on now rather than just, you know, the $4,300 that you got in income… and you’ll pay tax at 39% on that.
So, after the tax is paid – which is around $2,393 on that, you actually then get the franking credit back. So, the net tax on that is $523. So, you’ve received $4,300 of income after all the mucking around with the frank credit calculations, you’ll pay $523 net. That actually works out to be a marginal tax rate of around 13% on the dividend, rather than 39% so franking credits provide a very tax effective income.
The next, is family trusts. Family trusts just own an asset on your behalf, or the behalf beneficiaries, inside a separate environment. Rather than owning assets in your own personal name where you’re, every year, obliged to pay at your own marginal tax rate, family trusts allow assets to be owned inside the trust and depending on who the beneficiaries are, every year that income can be distributed to someone with a lower marginal tax rate. You can’t distribute your personal income though, it has to be an investment. So if you’re buying investments inside a family trust and they’re generating say $20,000 – $30,000 of income per annum, if someone’s on a very low marginal tax rate in the family, then you could distribute that income to them.
However – kids – they’re no longer a loophole. If you’re below 18 it’s about $460 you can give to a kid tax free. Then, for the next up to $1,300 or so, it’s 66% of tax, and then above that, it’s 47%
Then, salary sacrifice. You can actually put money into super pre-tax paying 15% of a contribution tax, rather than your marginal tax rates. And if it’s sitting inside super as well, it pays a maximum 15% tax again, rather than having an investment in your own name paying marginal tax rates.
If you earn $100,000 and you put $100 into super, sit back for 20 years, you’ll likely have an additional $180,000 – $200,000. And that’s at 6.40% return. And you would have saved around $25,000 of tax over that time.
Your net benefit is around $200,000 over that period – all for just $60 less per week in your hand. Just remember with salary sacrifice don’t let your employer contributions and salary sacrifice go over $25,000 because otherwise, tax!
Another great tax dodge …capital losses! Just lose some money on an investment. Then you can claim future gains against that. If you buy shares for $100,000 of value and lose 50%, and you dump it and sell, you’ve got a capital loss of $50,000 that you can carry forward every year until you gain a capital gain and then you can help offset that.
So, with Donald Trump not paying tax forever apparently, well, you too can do that if you just lose $916 million so you can essentially, indefinitely, offset any capital gains you get.
And that’s where the next strategy comes in if you are selling some asset with capital gains…try to time it so that you’re doing so in a year that you don’t have much of an additional assessable income. A great way to do that (probably way too down the track for most of us) but waiting to retirement, or waiting until maternity leave, or just waiting until you’re in a position where you’re outside of your normal assessable income to sell those assets. Because capital gains get added to your assessable income. So, if you’re generally working for $80,000 a year and you sell an asset (even if it’s had a $100,000 gain) $100,000 is just added against your assessable income. If you could wait an additional couple of years, if you’re on maternity leave or if you’re simply approaching retirement, then you can sell that asset and not have to pay the additional tax being added to your assessable income.
And, last but not least, superannuation and allocated pensions.
Allocated pensions have come under a lot of attack recently and can so I can sort of tell why when, if you’re above the age of 60 or your preservation age, you could convert your super account into what’s called an allocated pension or income stream. They’ve got many different names, but it’s all the same thing, where you can transition your super account into a tax-free account. So, all the investments inside there can be tax free. You can have a property inside an SMSF, you could have a $20 million gain. You could sell that while you don’t pay tax (if you’re in the pension environment).
Similar to all of the franking credits and other income that you receive in that environment, it just gets added to your income rather than paying tax. So, it’s really the most tax effective way of funding retirement, of just building that up, and then hopefully locking it away to the point the government doesn’t keep just grabbing tax off it.
And all these 8 different strategies to reduced taxes is really true equality. Anyone can do it. You all have 100% equal access. But, it just doesn’t make sense for a lot of people to do these because they’re not in a position where the costs involved in setting up, say a family trust, is worth the tax saving they would get.
Because if you’re not paying much in tax then setting up all these structures which cost a lot of money, doesn’t actually save you any net benefit. You might save some tax, but you’re paying probably more than what it’s saving.
Well, I hope these have helped – where if you’re paying tax that’s a guaranteed certainty every year, why not just try to improve your position a little bit. Increase your net cash flow by looking at ways to just simply reduce your tax. The most common for those ones we looked at, the major 8; negative gearing, salary sacrifice, claiming deductions, getting franking credits with shares, family trust, looking at capital losses…
So, if you can use these as well – that’s true equality. It’s just you probably haven’t lost a billion dollars so you can’t claim that as a tax loss indefinitely …and really when we look at tax, does the government deserve more money that is really not increasing the quality of service we receive? and we don’t know really how it’s spent, we get a chunk of a pie graph, saying “34% went here” and if you try to look into really how it’s being spent or what’s being divvied up, it’s very hard to find. It’s possible to really make the government accountable by that point, and if they’re asking for more, I think they should be fairly accountable to at least let us know where it’s going. Because we’re never ending source for them – they can legislate anything really, and unfortunately, they have the guns… so we have to abide …or go to jail.
So, if there’s going to be the message of trying to accept more of our taxable income, then it’s probably a good idea that we give a message back of just needing to be fiscally responsible first, before asking for more money. It’s like a kid who doesn’t want to work on their own and just keeps putting the hand out say more, more, more, more, more. Eventually one of the parents might give that to them, but then over time if they just keep handing out money, they going to go bankrupt.
So, I hope you enjoyed the episode today …and I’ll see next time.