Deconstructing why and how we pay our taxes

Every year around this time of the year my mind turns to tax as I start to do my own taxes.  I often grumble about taxes but I also realise that taxes are a necessary evil.  Any discussion about taxes and tax policy is filled with self interest and people looking out for themselves.

It is so hard to have a neutral discussion about taxes without people feeling that they are hard done by.  Low income tax earners point to the tax breaks that high income tax earners get and high tax payers point to the proportion of the tax system that they are funding.  Neither is wrong either...the tax system is far from perfect.

So what is the answer?

I recently saw a discussion piece by Vice News on this very topic and although it is very US centric the issues it discusses have a much broader appeal.  I found it incredibly enlightening and the people on the panel were experts in their field, able to leverage off each other for one of the best discussions on a complex topic that I have ever seen.

I cannot recommend this piece highly enough...enjoy!

I'm a high income earner...and this is why I have NO problem with the Warren Buffett Tax

A few years ago I started writing a whole heap of posts on politics.  It is something I'm really interested in but this wasn't the best venue for it so I swore off it.  My "no politics" rule is still in place but I do talk about tax quite a lot on this blog and I thought today I would focus on why I don't really have any objection to the Warren Buffet rule that politicians are currently considering.

What does the rule say?

Basically the rule says that high income earners should be paying their fair share in taxes.  In the Australian context this has been expressed as anyone earning above $300,000 should have a minimum average tax rate of 35% regardless of any deductions they may have.

Why is it called the Warren Buffet rule?  Well it was proposed by legendary investor Warren Buffet who argued that legally the tax he paid was less than his secretary which seemed crazy and not right to him.  He proposed this rule as a way of plugging a lot of loopholes at once.

This isn't actually as bad as it sounds

In Australia if you were earning $300,000 per annum and had no tax deductions you would be paying tax of approximately $117,000 which is about 39% and you would be in the top marginal tax bracket of 49% (including the medicare levy and the budget repair levy). 

Now it doesn't sound like it would take a lot to get your tax rate down to 35%...but it actually isn't as bad as you think.  For someone earning $300,000 their minimum tax payable would be $105,000.  Under the current tax rates this means they would actually be getting taxed as if they were earning ~$276,000 which still gives you a hefty $24,000 in deductions.

But let's be honest...these measures aren't aimed at people earning $300,000.  Let's look at someone earning $1 million.  If they had no deductions they would be paying $460,000 in tax.  The proposal says that they should pay $350,000.  They are still allowed $224,000 in deductions before they hit the minimum barrier.

Aren't I disadvantaged by a proposal like this?

Honestly the reason I decided to write this piece was not because I think it is the right thing or policy (which I do) but it's because the people that need to speak in favour of proposals like this when it is a good idea are those that are earning high incomes.

Does it disadvantage me?  Honestly...no.  I pay my fair share in tax and I don't try and overly tax plan what I do.  I don't skate close to the line and I just checked my last year's tax statement and I actually did pay 35% of my income in tax (even though I earn significantly less than $300,000).  If I earn less than $300,000 and am paying 35% in tax....why is someone earning more than me entitled to pay less tax?

I'm not asking this question in a legal sense.  Of course if you can legally avoid tax you should do so!  That's the whole point of tax planning and I don't think tax planning is a bad thing. You shouldn't pay more tax than you have to.

BUT there are always going to be loopholes that people miss and that politicians don't want to fix for one reason or another.  A blanket rule helps insure that people can still pay less tax and minimise their tax but not take the system for a ride.

Why do I like the rule so much?

Why do I like the Warren Buffet rule enough to break my 'no talking about politics' rule?  Simply because it is neat, effective policy which is being slammed by those who have a very clear interest in keeping the system as it is.

Why is it neat?  Well everyone is going to have some legitimate deductions and those legitimate reductions are probably going to increase as your income goes up (for a variety of reasons).  The Warren Buffet rule doesn't get rid of deductions, in fact it doesn't really change the tax code at all.

Feel free to use all the deductions you want but there is a cap.  There is a point at which you should still be contributing to the system and a point at which people who are earning significantly less income than you shouldn't be paying more tax than you.

If the rule is designed well you could have unused deductions carrying forward into future periods.  Maybe a high income earner will never pay more than 35% and maybe that's where structuring takes us but at least they are still contributing to society and the system that we are all a part of.

Have I missed something?

Look I'm not claiming to have analysed this situation perfectly.  Maybe I've missed something.  Maybe there is something behind all the furor.  Can you see something I haven't?  Is there some reason why this isn't a good idea?

One reason I've seen touted is that high income individuals will just move overseas.  I don't buy this argument.  Tax rates are already lower in places like Hong Kong and the Middle East.  If people were going to move for tax reasons they would have already done so,.

But is there something else?  I would love to hear what you think!

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Negatively Gearing the Stock Market

This is a guest contribution from Jeremy Kwong-Law

We have a national obsession with property investment in Australia. A key reason is because of the tax benefits of negative gearing. The idea of paying less tax is simply too appealing to most people (who can afford it).

Negative gearing only makes sense if the capital gains on the asset is more than the interest cost. Otherwise paying less tax is really because you are making less money, and losing wealth along the way.

Most people only think of investment property when they think about negative gearing. But there are actually other asset classes where negative gearing can be effective. The stock market is one of those.

Individual stocks are too risky to apply a long term negative gearing strategy. However, index based Exchange Traded Funds (ETFs) could be a suitable option. I previously wrote about why ETFs are a better way to achieve a diversified portfolio compared to direct stock holding (here).

With this concept in mind, I tested a $500K investment in the SPDR ASX 200 ETF (STW) using a negative gearing strategy. A $500K negatively geared investment property in Sydney was the comparison case. I selected the SPDR ETF because it is the oldest index ETF listed on the ASX, providing the most data points.

Over an investment time-frame from 1 Jan 2005 to 31 Dec 2014, the investment property offered better outcomes through negative gearing:

• Return on Equity on the property was 206% compared 104% from the ETF
• Total tax offset for the property was $214K compared to $116K from the ETF

 Despite this, the analysis shows that negatively gearing the Aussie stock market is a viable option. In fact, ETF offered a few benefits compared to property investment:

• Lower entry cost - A deposit for an investment property is likely to cost more than $100K, whilst you can start an ETF portfolio with a few $1,000s
• ETFs are much more liquid than property
• there is a lot less hassle compared to property investment. ie. no need to manage tenants / real estate agents
• lower transaction costs - buying an ETF is as cheap and simple as buying a stock with your online broker. Buying an investment property is difficult and expensive. You need to consider legal fees, stamp duty, and other costs

Funding

To fund the two investments, I assumed a loan at 65% LVR or $325K. This leaves a $175K equity / cash investment at the start. The mortgage's variable rate is based on the RBA’s published rate across the 10 year period. The Margin Loan for the ETF is assumed to be 2.85% p.a. more expensive than the mortgage. This difference is the spread between a CommSec Margin Loan and a CBA mortgage as at May 2015.

Both loans are repaid on a monthly basis, to the same dollar value. At the end of the 10 years, principal outstanding is $256K (79% of the initial loan amount).

Running costs & other tax offsets

The cost of the ETF is completely absorbed within the unit price so there are no other fees to pay - ever. For the investment property, there are a few costs:

• Real estate agent management fee of 6% of rental income;
• Depreciation on the property - I assumed 40% of initial investment is depreciated (some consultants suggest you can depreciate up to 60%!).

Income

The ETF pays a semi-annual dividend. Over the 10 years, it provided an average annual yield of 4.7%. I did not factor in franking credits.

The property starts off at 3.5% gross rental yield. Rent rise every year in December, at the rate of Sydney rental growth (ABS data). Over the period, average annual yield is 3.8%.

Asset Value

Property value in Sydney achieved big growth in the past decade, gaining 58%. The $500K property in Jan 2004 was worth $792K in Dec 2014. The Aussie stock market didn’t do as well over this period. The ETF share price increased from $40.79 to $50.25, a rise of 23%.

The higher asset value growth of property also translates to much higher equity value growth. Equity in the property grew from $175K to $536K, an impressive 206%. The ETF equity value grew from $175K to $357K, a 104% increase.

Tax offset vs cash flow

Obviously this whole strategy is about tax offsets - both investments achieved this. The property had tax offsets of $213K over the 10 years, whilst the ETF offered $117K of tax offsets.

Interestingly, the property offsets were achieved with lower impact on cash flow. Negative cash flow for the property investment was only $82K over the 10 years. The ETF had $117K of negative cash flow. This is mainly because property is able to claim non-cash tax deduction in the form of depreciation.

What does it all mean?

This is another example how why Aussies love investment property and negative gearing. You can achieve strong net wealth growth and tax offsets - a double whammy. This also shows that a negative gearing strategy can be applied to other asset classes.

Investing in ETFs is a way of achieving negatively geared investment in the share market. A core benefit of ETFs over individual stocks in this content is diversification - reducing risks. The risk of investing in a Sydney property and the SPDR ETF was similar in the 10 years. Sydney property prices had a standard deviation of $83K, whilst the SPDR ETF measured in at $84K.

On the face of it, investment property seems to be a more compelling investment class. They offer higher returns, more tax offsets and lower negative cash flow. However, I didn't account for a few things that are negative for property investments:

• stamp duty and other taxes;
• vacancy risk - if you can't rent out your property you get no income;
• significantly higher legal fees;
• higher transaction costs when you sell the asset, real estate fees of at least 1%.

The high cost of entry is also a critical issue for investment property. Currently, 1-in-3 Sydney suburbs have median home price of more than $1M. The initial cash deposit required is well north of $100K. For younger investors, this is a tough ask – an idea of reaching that deposit sooner is HERE.

Younger investors can explore the benefits of negative gearing through other asset classes. The asset must be able to achieve higher capital growth than the interest cost. One obvious option is the stock market, which usually delivers higher long term returns than all other asset classes. If negatively gearing the stock market is an interesting strategy, an investment in index based ETFs are a good option to start.

Do you negatively gear the stock market?  Share your thoughts in the comments below!

Jeremy Kwong-Law (@jeremykwonglaw) is Cofounder of www.BetterWealth.com.au. He is a former investment banker turned technology entrepreneur, a muru-D alumni (Telstra startup accelerator). Passionated about leveraging technology to provide better financial products & services to consumers. Coffee snob, business book reader, and fitness fan.

How do you keep track of your share trades?

It's coming up to tax time and normally at this time of year I write a post on how you should start to think about your tax time affairs and start to get your affairs in order.  This year however I'm going to do something different.  I'm going to present a problem that I have...the solution I current use...and see if you have a better solution to this problem.

Problem: I don't have a good system of keeping track of my share trades for tax purposes

One of the biggest problems I have as someone who buys and sells shares is keeping track of the trades for tax purposes.  

It's not that I don't record every transaction that I make - I do and I am meticulous about it.  The biggest problem is working out the tax implication of every sale that I make.

The problem I have is keeping track of working out what is the optimal parcel of shares to sell and the number of shares remaining in the parcel

The problem really exists where you have bought shares over a period of time, either through dollar cost averaging your way into a stock or when you have been participating in a DRP and have been accumulating shares

I did my own taxes...and it was great!

I am usually terrible at doing my taxes on time.   I always have the receipts sorted out and spreadsheet done well in advance however when it actually comes to seeing the accountant and submitting my taxes I tend to procrastinate for weeks or even months.  Last year I submitted my taxes 6 months late.

This year I swore I would be different.  But not only that...I also decided to do my taxes myself

Why did I do my own taxes?

There are a whole host of reasons I decided to do my own taxes this year including:

1. I virtually do them for my accountant anyway!
• The spreadsheet I give my accountant is so detailed it means he never has to look through any of my documentation and I generally only have a few questions that I need to ask him
2. I value my time less than my accountant charges me
• My accountant charges $120 per hour to do my taxes and given the work I normally do on them I generally only get charged for 2 hours of work (i.e. $240)
• I wasn't exactly sure how long it would take me to do my taxes but I was pretty sure I would be ahead if I did them myself
• As it turned out it took me 4 additional hours to do my taxes (i.e. the time taken to do what the accountant usually does) 
• I value my personal time at less than $60 per hour so it was a great trade for me
3. I hate taking time off to go to my accountant
• I normally have to take a bit of time off work to go to my accountant who works in the suburbs (while I work in the city).  Work doesn't have a problem with this but half the reason I generally procrastinate for so long is that I find it such a waste of time to go out there
• I thought about getting an accountant that was more convenient but this one knew my personal financial situation rather well and I didn't feel like having to explain it to someone new all over again

Would I do my own taxes again?

Going on holiday? Get some tax back using the Tourist Refund Scheme

If you're an Australian like me and travel overseas you have probably noticed that the immigration form on the way home has a question about whether you are importing anything in the country with a value over $900.  Did you realise that there was a way that you could save money even if you don't buy something overseas?

What is the Tourist Refund Scheme?

The Tourist Refund Scheme (TRS) is an initiative by the Australian government to encourage people to buy goods and services in Australia.  It allows you to get back the tax you paid on the item when you leave the country with that item.  For most items this will be the Goods and Services Tax (10%) that you paid although for some items it may be even higher (e.g. wine gets 14.5% back).

What are the eligibility requirements?

The eligibility requirements are actually rather simple.  The goods need to be

• Purchased in the 60

It's Tax Time: Here are 4 things you should do before 30 June

Can you believe the end of the financial and tax year is already here?  It seems to come around quicker every single year! You have just a few days left to get your some last minute tax structuring done before the year comes to an end so I have compiled a list of things that you may want to consider doing.

Here are 4 things you should think about before the end of the financial year:

1. Calculate your capital gains tax bill and work out if you need to trade

You should be doing this at the end of every financial year.  I have posted about this idea in far more detail but here are the basics

• You can't offset your capital gains tax losses / gains against your other income (as you can with your investment property)
• If you have a tax gain or loss you can net it off with another position that you may want to exit 
• If you have a CGT liability for the year and have unrealised tax losses you can realise the tax loss and then re-enter the position again in the new financial year
• Note that this creates a new tax base and transaction costs but it may be worth it due to the time value of money

2. Donate to charity before the end of the financial year

If you have been thinking about donating to charity now is a great time to do it.  The charity is probably going to be indifferent between receiving it now or in 5 days time but you get the tax benefit this year instead of next year.

Don't forget that in order to do this you have to have a tax receipt!

3. Work out if you can front end any tax deductible expenses

Do you have tax deductible expenses that you are planning to make?  Perhaps it is salary sacrificing into superannuation or perhaps you need to do some repairs on your investment property or get a depreciation report for your investment property.  

If you have an expenditure which is tax deductible you should think about making these expenditures (or pre-paying these expenditures) before the end of the financial year.  Again this has to do with the time value of money (i.e. a tax deduction now is worth more to you than a tax deduction in a years time).

4. If you are over turning 31 or are already 31 and don't have health insurance consider getting cover

I recently did a post on the Lifetime Health Cover loading which applies if you don't have health insurance by the 30th of June after your 31st birthday.  It really is quite a big stick and if you are thinking about getting health insurance at any point in your life you should be aware of the implications of the LHC loading.

If you're already over 31 keep in mind that the longer you wait the more you are going to get hit when you eventually decide to take cover.  So if you have turned 31 this year or are above 31 consider taking out health insurance before the end of the financial year.

Save time, save money and make your life simpler at tax time

Getting your financial affairs in order before the end of the tax year can save you time, money and make your life simpler when it comes to tax time.  This year I have made sure that my financial affairs were in order well ahead of time so that I could fire my accountant and do my own taxes.

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The Lifetime Health Cover loading can really sting...so think about it before June 30

See All Tax Posts

The Lifetime Health Cover loading can really sting...so think about it before June 30

This post is written for Australians in the lead up to the end of the financial year.  If you turned 31 in the last financial year and don't have health insurance then you should really consider getting it otherwise the Lifetime Health Cover loading will bite you quite badly.

At the end of every financial year you will notice that health insurance companies start advertising quite heavily and advising their customers to get health cover before June 30 in order to avoid the Medicare Levy Surcharge.

I have written before about how you shouldn't get fooled by this.  The surcharge will apply for the percentage of the year that you don't have health insurance.  So if you get coverage on the 29th of June and earn above the threshold ($88,000 for singles and $176,000 for families) you are still going to have to pay the surcharge (1.0% - 1.5% depending on your income) for the 364 days you didn't have coverage.  You should still get the coverage to avoid the tax...but there is no real rush to it.

However the Lifetime Health Cover loading is time dependant and if you don't have health cover and you turned 31 in the last financial year...you definitely need to get health insurance before June 30!

What is the Lifetime Health Cover loading?

The Lifetime Health Cover loading is an initiative by the Australian government to encourage people to take out health insurance when they are still young and keep this health insurance going.  It stings you if you don't have health insurance now but if and when you decide to get it at some point later in your life.

The Lifetime Health Cover loading is a huge stick to encourage you to get health insurance before you turn 31.  Read on to find out how it works.

How does the Lifetime Health Cover loading work?

If you do not have hospital cover on the 1st of July following your 31st birthday (assuming you turned 31 after 1 July 2000) you will have to pay a loading when you do decide to take out health insurance later in life.

The loading is calculated as 2% for every year you are uninsured for every year you are over 30.  For example if you decide to first take out health insurance at age 40 you will have to pay 10 years x 2% = 20% more for your health insurance than someone who was covered the whole way through. This loading lasts for 10 years from the point you first get hospital cover. 

What if I don't want health insurance?

Fire your accountant and do your own taxes

I'm firing my accountant and doing my own taxes this year.  I have written before about the dilemma regarding whether to use an accountant to do your taxes.  For the last 2 years I have had an accountant do my taxes for me.  It provided a safety blanket however it had downsides as well such as

1. Having to take time off to go and see the accountant
2. Having them take longer to do the taxes than I would myself

I have therefore decided to do my own taxes from this point forward

The more I thought about it, the more I realised that people like me should really be doing their own taxes.

You should do your own taxes if...

...You completely understand your own financial situation

If you completely understand your own financial situation or are looking to really take control of your financial situation then you should really consider doing your own taxes.  Unless you have companies embedded within trusts and a lot of complicated structures set up it is quite easy to do your taxes yourself.

In Australia the Australian Tax Office makes it quite easy to do this.  They give you a program which helps you work your way through your taxes and the guides on their websites are reasonably simple and easy to understand.  I don't know what other countries' systems are like but if it is anything like Australia you really should be able to work it out.

If you really have no idea

Positive Dilemma: Is it an issue if your property becomes positively geared?

In Australia, one of the biggest benefits of investing in property, or borrowing significantly to invest in any investment class (including shares) is the presence of negative gearing.  That is, you can claim a portion of your losses (your effective tax rate) back against your other earned income.

Although a loss is always a loss negative gearing allows you to

• Supercharge your investment returns by investing less cash and using leverage to maximise the growth in your invested capital
• Have lower holding costs while you wait for capital growth to give you the returns mentioned above

How to investment properties become positively geared?

There are several ways that this can happen without you even noticing it:

1. You have been paying down a little bit of principal every month or have been contributing to an offset account and your interest bill becomes lower than the rent
• This is a really common way for investment properties to become positively geared
• You have managed to save so well and pay down your debt so aggressively that your investment property is now throwing off cash to you each month
2. Interest rates have fallen
• Typically we pay more attention when interest rates are rising because we know that we probably need to contribute a little bit more each month
• However when interest rates are falling most people do not tend to take as much notice
• It is entirely possible for interest rates to fall so much that your property goes from negatively geared to positively geared very quickly
3. The rent you charge goes up
• It is perfectly normal to increase the rent you charge ever year
• Because the incremental amount is so small (i.e. typically $5 - $10 a week) we tend not to notice it on a month to month basis 
• However over a few years it definitely narrows the gap between what you are paying in interest and what you receive from your tenants

Why does this cause a dilemma?

There are several investment books (which I don't like) which bemoan the fact that people are so focused on negative gearing and promote the idea that positively geared properties are ideal because 'they put money in your pocket each month instead of taking it out.  This is only right at a very simplistic level.

However it is not so simple if you think about your whole portfolio, instead if this investment in isolation.  What you should actually think about is: 

What the opportunity cost of having your funds invested in this property versus in another product?  

As I mentioned earlier what negative gearing allows

Employee share plans: Make sure you calculate your tax properly

This post will be relevant only to Australian tax payers as it will have to do with a quirk in the tax system which means that you need to take special care about how you calculate your capital gain and tax payable on the income you make from the sale of your employee share plan shares.  Keep in mind that these rules keep changing and this is accurate for the 2013 financial year.

I have recently encouraged everyone to look at their portfolio and perhaps do some trades to avoid having to pay capital gains tax at the end of the financial year.  If you are not careful you could actually end up over or under estimating your actual capital gain and then trade needlessly

A recap of the basics

I posted more than a year ago about the basics of employee share plans and how you can make some money out of them.  They basically have some similar characteristics which include:

1. They are issued at a discount to the market price
2. You can sell them as soon as they are issued to you (they do not come with hold periods)
3. When it comes to maximising your profit you have the choice of selling them straight away and making the discount in a risk free manner or you can hold onto them in the hope that they will appreciate more and sell them later in which case you can make more or less of a profit

The discount causes a tax quirk for Australian tax payers

Normally when you buy and sell shares you just look at the price which you paid for the shares and then look at the price which you sold them at including things like exchange rate movements and accounting for your transaction costs etc.

However if you look at the tax rulings given by the ATO (there is a whole section on shares issued to employees under employee share schemes) there are a few things that you need to keep in mind:

1. The discount on the shares counts as part of your assessable

2013 Tax time reminders

With only 5 days to go until the end of the 2013 financial year I thought I would remind you not to fall into some common traps.  I have posted on these previously but they are good to remember before the end of the financial year.

90millionblog's tips leading into the end of the 2013 financial year

1. Do not get sucked in by health insurance ads - it's already too late for this year
• Every single year around tax time the health insurance advertisements remind you that you will get slugged an extra amount at tax time if you earn above the threshold and do not have private health insurance
• They argue that you can still get cover before June 30
• This is technically true however the tax penalty is paid for every day you are not covered for the financial year
• If you didn't have cover you are going to get slugged anyway so take the time to find the right health insurance for you so you don't have to pay this amount next year
2. Calculate your capital gains for this year and work out if you need to trade
• In Australia capital gains cannot be offset against losses on your investment property - only against capital losses
• If you have a realised capital gains in the

Only 1 month left until the end of the financial year! Are you ready?

Any readers that happened to be reading my blog around this time last year would know how excited I get around tax time.  Before you ask....I can assure you that a) Yes...I have a life and b) No...I am not nuts.

There are a few reasons that I love this time of the year including

1. Getting my income tax refund
• Like all sane people, I realise that my taxes are necessary to fund those things in society which can only be provided by a government, however that does not mean that I can't grumble about how much I pay in tax
• Due to my investment property I get an income tax refund every year and it is very nice getting this back from the government
2. I can justify big expenses on tax deductible items
• I am a little bit of a technology geek and I love buying new gadgets - however given I also am trying to save money I have been having a hard time justifying this expenditure
• However if you are planning on buying an item that you can tax deduct (e.g. a laptop) then you have to do this before the end of the financial year (note that I'm planning on claiming my Nexus 7 as I use it for work purposes)

Most of us only start thinking about our taxes after then end of the financial year...this is silly...

It makes much more sense to start thinking about it much earlier.  There is now exactly 1 month left before the end of the financial year which should be plenty of time to think about how to maximise the

Donating to charity: Save tax and benefit society at the same time

In many countries' tax code there is a deduction available if you donate money to organisations that have charitable status.  What this means is that it costs you much less than you are actually giving and still yields the same benefit (because effectively the government contributes your marginal tax rate).  I don't think this would surprise anyone but it does mean that you can do the most good by planning your charitable givings a little.

Overview: Tax deductions for charitable donations

Where a deduction is available for a charitable donation the system works as follows

1. You donate money that is recognised by your tax system as being a charity.  Charities have to apply for a special tax status for this to be the case but nearly all reputable charities have this already in place.
2. You claim this deduction back on your taxes at the end of the year
3. Note that you have to keep your proof of donation (either through a receipt or summary statement sent to you by your charity) in case you get audited.  For example in Australia you need to keep all your tax records for a minimum of 7 years.
4. You receive back your marginal tax rate from the government in the form of a tax return.  If your marginal tax rate is 30% therefore this means you are only donating 70c of your own money for every dollar of good that your donation is doing

Structuring your donations for tax purposes

Governments intentionally make it easy to claim back donations on tax because charities perform social functions that governments are either unable to or don't have the funds to do (keep in mind that it only costs the government your marginal tax rate to see the charitable services provided).  The only slightly annoying thing is keeping records for tax purposes.

If you donate money to a stall on the street or to collectors that you pass on the street the issue is around proof of donation.  I don't know many people that would stay around and wait for a receipt for a $20 donation because it perceived as too much effort.  I'm the same - if I donate money to a charity that is collecting on the roadside etc then I would never ask for a receipt even though your charitable donations add up (as does the amount you receive back from the tax office)

The best way to structure your donations therefore is through regular payment plans

• You can donate however much you like through the payment plans.  Charities always push you for larger amounts but just stick to what you can afford
• At the end of the year they send you a receipt totalling your donations throughout the year
• They also have your donations on file should you ever lose your receipt and need it in the future
• You also have proof through your bank and credit card statements should the tax office ever require it
• Most importantly it is much better for the charity because then they have more certain cash flows and are able to plan their activities much better

Keep in mind that some activities by charities are not tax deductible

This varies on a country by country basis and the charity you are donating to, especially if they are a large reputable one will explain to you what is deductible and what is not. 

For example in Australia if you donate to a religious charity they will often ask you whether you want your donations to come with a tax receipt.  This is because tax deductible donations can only be used for certain purposes such as health services, education, helping the poor.  They cannot use tax deductible donations to provide religious services such as missionary services.  You may want to provide these missionary services so would opt not to receive the tax benefit back.

The best way is to ask the charity and they will tell you up front what they can and cant do with the money.  As long as you are informed about your choice then I think either option is fine. 

Should you do your own taxes or use an accountant?

I think that this is a question that gets raised every year by almost all people who submit their tax returns.  Those who use an accountant wonder if they should save money and do it themselves and those who do it themselves wonder if it isn't worth the money paying for an accountant so they can save some time.  Below I have outlined the situations in which you should do your own taxes versus when you should use an account

Before I go into the issues I will admit to having an inherent bias.  I believe that people should, to the greatest extent possible, have as much control over their financial lives.  This means that I think people should be making their own investment decisions whether it be related to taxes, shares, loans etc.  The major benefit of doing this is that you are less likely to get ripped off or surprised by anything that happens.  The downside is that you can never blame anyone for your financial mishaps.

Benefits of doing your own taxes

• Cost: You save the complete cost of the accountant which often range from a couple of hundred dollars to thousands of dollars for complex cases
• Understanding:  You understand completely what you can and cant claim.  This can help you make better decisions in the future (which in turn helps you save more money by making wise tax choices)
• You will often get your tax return quicker:  Accountants are often swamped at tax time and while they will get your returns done it will probably be a while before you get your tax return as they tend to submit them in batches

Benefits of using an accountant

• Time: You save the considerable time it takes to do the tax returns every year. 
• Less likelihood of mistakes / missed deductions:  You are more likely than an accountant to make a mistake when it comes to claiming something or worse forget to claim a deduction you ordinary may be able to which can cost you money
• Do not understand the rules when it comes to complex cases:  When there are entities like trusts set up the rules become a lot more complex and not many people understand them all fully

Is there a happy compromise?

I believe there is a compromise that most people overlook.

Tax time: How does salary sacrificing work?

This post will go through how salary sacrificing works and how you may be able to save significant amounts of money on large purchases if you employer lets you enter into these schemes.  Please note that this is for Australian tax payers only (I have no idea if this system is applicable anywhere else in the world). 

The most complete source of information is the Australian Tax Office website so I'd visit there as well but as they do not really simplify the issue I thought I would summarise it here.

What is salary sacrificing?

Broadly speaking it is entering into an arrangement with your employer whereby you forgo part of your salary for a product / service / good that is provided to you.  The most commonly used example is an arrangement of cars:

• You enter a lease agreement for a car which your employer pays for
• This includes all maintenance, insurance, petrol etc
• This is paid out of pre-tax dollars
• Your employer has to pay fringe benefits tax for this service provided to you
• The fringe benefits tax is normally also taken out of your pay

Why would I use salary sacrificing - shouldn't I just purchase or lease the car myself?

The benefit you get is because of the different tax treatments for income tax and fringe benefit tax.  It would be worth your while entering into the salary sacrifice agreement if your marginal tax rate is above the fringe benefits tax rate.  For cars the FBT rate is currently 20% which means if your marginal tax rate is above 20% you can save money by entering into this kind of arrangement.  It varies between different classes of benefits so is always best to check it out before entering into an arrangement.

Note that on some products there is no fringe benefits tax payable.  These are the products that are really good from a salary sacrificing point of view.  They include things like portable electronic devices, security, work clothes and tools. 

How do I enter into a salary sacrificing arrangement?

The first thing to do is talk to your employer.  Not all employers offer it unfortunately.  If you do enter into an arrangement make sure you adhere to the following:

• Make sure the arrangement is in writing - it doesn't technically have to be but if the ATO asks you to prove it later it is pretty hard if it is a verbal agreement
• The agreement needs to be for future services you provide - you unfortunately cannot enter into retrospective arrangements
• The salary you forgo needs to be forgone for the entire period of the arrangement - for a car this means for the entire time your firm is paying your lease payments and other costs

What should you watch out for in salary sacrificing arrangements?

Reportable fringe benefits - if the grossed up value of the benefit you are getting (i.e. the value divided by your marginal tax rate) is greater than $2000 then this gets reported on your tax statement.  This does not make any difference to your income tax but you will have to pay a higher medicare levy and it impacts the rate at which you have to repay your student HELP loans.

You can elect to contribute part of the payment (normally an amount equal to the FBT the employer would usually have to pay) - this actually saves you a fair bit of money because you actually lose less money to your employer.  The best example is the one provided by the ATO.

What products can I use it on?

There is no restriction on the products.  It is normally used for large purchases including cars and property.  It is also a fairly common way of contributing to your superannuation (see my previous posts on salary sacrificing into super).  There are special rules for superannuation.

Insurance: How does the medicare levy surcharge work?

A quick pre-tax time tip re health insurance.  Every single year before June 30 health insurers go on an advertising binge telling prospective customers to 'get in before June 30'.  This is aimed at those who, because they earn above a certain limit and do not have private health insurance, are charged the medicare levy surcharge. 

However please note that the surcharge you pay is based on the number of days covered by health insurance during the year.  Getting health insurance right before June 30 does not eliminate your obligation to pay the surcharge for the rest of the year.

For example if you were to get health insurance on the 26th of June and earned above the threshold (e.g. assume you earned $100,000 and were a single person) then your Medicare levy surcharge would for 2011 / 2012 would then be:

• Number of days uncovered / Days in a year = 361 / 365 = 98.9%
• MLS surcharge on income = 1% * 100,000 = $1,000
• MLS obligation for the tax year = $1,000 * 98.9% = $989

So there is no real incentive to take up health insurance before the end of the financial year but there is definetely incentive to take it up quickly. Further the intoduction of a tiered surcharge system means that all middle and high income earners should look very seriously at what health insurance would best suit them.

Background - how does the Medicare Levy Surcharge work?

The medicare levy surcharge is a tax based incentive to get insurance.  It works as a big stick - if you earn above a certain limit and do not have health insurance then you pay an extra tax (which can be quite steep).  I have outlined below the incomes at which you become liable for the surcharge for the 2011 / 2012 financial year (note that income includes gross wage, reportable fringe benefits and employer superannuation contributions)

Category	Income Threshold	Surcharge
Single, No dependents	$80,000	1%
Single, Depdendent children	$160,000	1%
Couple	$160,000	1%

In the 2012 / 2013 year there has been a change to the way in which the MLS is calculated including a significant increase in the MLS if you do not have private health insurance. There was also the introduction of a tiered system - Below I have outlined the new MLS thresholds and surcharges.

	Unchanged	Tier 1	Tier 2	Tier 3
Singles	<$84,000	$84,001 - $97,000	$97,001 - $130,000	>$130,000
Families	<$168,000	$168,001 - $194,000	$194,001 - $260,000	>$260,000
Surcharge	0.0%	1.0%	1.25%	1.5%

Tax time: Depreciation Reports for Investment Properties

This post is part of both my Investing in Real Estate series and my series on tax measures in the run up to the end of the financial year.  All investors in real estate in Australia should get a depreciation report done on their investment property before the end of the financial year end.

Depreciation reports are a schedule of the value of the fixed assets in your property.  This includes all your fixtures and fittings such as lights, cabinets, bathroom tiles etc.  It provides the depreciable value of your property every year which is counted as a an expense for tax purposes.  The beauty in depreciation is that, as a non cash expense, it is effectively 'free money' you get back from the government in the form of

• A lower tax bill; or
• A tax return

You do not need to spend money for a depreciation report and you can estimate the value of the depreciable items yourself however if you are audited and the ATO sees that you have done this they are more likely to investigate the values you are claiming.  The best way to get an accurate estimate of the values (and not to miss anything!) is to use a good Quantity Surveyor. 

Quantity Surveyors are not abhorrently expensive (should be in the region of ~$700) and generally pay for themselves in the first year Note that this amount is tax deductible so you're actual out of pocket cost is more like ~$500). 

• I used depreciator.com.au which was recommended to me by several other property investors.  I found them to be highly professional the report they produced was perfect (and my accountant was very happy with it. 
• I have heard bad things from other (cheaper) providers of this service so I would recommend going with these guys. 
• I have no affiliation with them (other than being a previous client)
• If you mention that you heard about them from the somersoft website (a property forum for Australian investors) then they should give you some sort of discount (I got a $55 discount when I did this). 
• If enough people mention this site in addition (i.e. don't lose your discount) I will try and negotiate a standardised discount for my readers. 

How much will I get back from a depreciation report?

The amount you get back will vary depending on the age of your property and any additions that have been made to the property.  Generally speaking

• Newer properties will have higher depreciable values and so you will get more back
• Renovations tend to get a lot back
• There are some build dates where you can depreciate the construction cost of the property (including the bricks etc).  Check out this ATO document to see whether your building falls within this category 

To give you an example my property is a relatively old one (built in the mid 1970s) but has a renovated kitchen / bathroom etc.  In my first year of ownership I claimed a $4,000 deduction and got $1,600 back as a result.

Some older properties will not get this much back because they have had very little done to them since they were built.  If you call depreciator they will be able to tell you whether it is worth getting a report or not.  They are fairly honest about it too as they trade largely on their reputation.

What is the difference between the diminishing value method and the prime cost method?

You will notice on your depreciation report that you have the choice to deduct tax based on a diminishing cost method or prime cost method.  Over the long term these will yield the same amount back on tax but it affects the timing of the deductions.

The diminishing cost method provides a greater deduction up front (close to twice as much) compared with the prime cost method. 

• High income earners should always take the up front deduction (diminishing cost method) as you will get the greatest benefit from the tax return and you get the money quicker (time value of money)
• Low income earners who believe their income will increase substantially should use the prime cost method because you only get back value based on your tax rate.  If you foresee your tax rate increasing substantially in the future you may get more back over the life of the investment by deferring some depreciation to later on

Over the life of the investment it makes little or no difference.  I use the diminishing cost method because I do not foresee my income tax bracket changing and I would rather have the cash now than later.

Beware developers who offer depreciation reports with a new property

Developers are more than aware that there is a tax incentive to buying a new property for your investment as you get greater amounts of depreciation.  This value is almost always built into the property when they know they are selling to investors.

I generally do not buy new properties or properties off the plan for this reason.  The developers know every possible advantage from a tax perspective and build this into the price of the property so that they get the benefit.

Tax time - Should I repay my HELP debt early?

In Australia, we are lucky enough to have a system where everyone can afford a higher education.  The government will fund undergraduate education for every Australian resident under the Higher Education Loan Programme.

The programme is very simple and is outlined below

• While you are at university the government funds your tuition fees
• You incur a debt to the government
• The debt is indexed to inflation (i.e. it is the cheapest debt you will ever get)
• When you earn over a threshold amount ($47,195 for the 2011 / 2012 tax year) you then have to start paying it back (gets taken out of your income like income tax)
• The rate of repayment varies depending on your income - see table below for the 2011 / 2012 repayment thresholds

	Repayment rate (% of repayment income)
Below $47,196	Nil
$47,196–$52,572	4.0%
$52,573–$57,947	4.5%
$57,948–$60,993	5.0%
$60,994–$65,563	5.5%
$65,564–$71,006	6.0%
$71,007–$74,743	6.5%
$74,744–$82,253	7.0%
$82,254–$87,649	7.5%
$87,650 and above	8.0%

This repayment rate is compulsory.  The question arises of when should you repay your HELP debt early?

At first glance there seems little incentive to repay your HELP debt early.  The implied interest rate (inflation) is the cheapest debt you will ever get so you should really use your cash for other things (which you would normally borrow money for) such as investing or buying a house etc.

However the programme incentivises you to repay your debt early by providing discounts for early repayment.  After 31 December 2011 this incentive dropped to 5% for all amounts paid above $500. 

• The benefit is therefore 5% + inflation (i.e. the amount your debt would have increased by)
• Assuming inflation of ~2.5% this means that by paying early you get a total return of 7.5% guaranteed on your cash which is nothing to sneeze at but not spectacular either (at the moment you can get that as a dividend return on high yielding Australian bank shares)

There is one situation however where you should always repay your debt early.  If you are due to finish repaying your HELP debt in the current year through compuslory repayments (i.e. in the table listed above) you should pay your debt off before the tax office calculates it.  I realise this sounds a little confusing so let me outline what I mean

• The tax office calculates your HELP obligation when you submit your tax returns (about July / August)
• It does not know how much your employer has been taking out of your paycheck until this point
• Assume you have $5,000 of HECS left on your debt and your employer has taken this out of your pay packet and already sent it to the tax office - they do not know this yet
• In June (before the end of the financial year) you can pay (5000 / 1.05) = $4,762 to the tax office to satisfy your HELP debt
• In July / August when you submit your tax return the tax office will realise that you have paid off your debt but your company has sent them an extra $5,000 through the year and so will return this to you
• You get the extra benefit of the $238
• This is actually a pretty decent return on cash outlayed
• $238 / $4762 = 5% over 2 months
• 30% annualised return

Note that the above example only works in the year where you are due to finish repaying your HELP debt.  In other years your contribution will just further reduce your HELP balance and you will only get a 7.5% annualised return.

Tax time: Salary sacrificing into superannuation

In the lead up to the end of the financial year I am doing a series of posts on last minute things you can do to reduce your tax.  This post will also tie in with the superannuation series I have been writing over the past few weeks. 

In previous posts I have mentioned that under Australian law your employer has to contribute 9% of your total wage (including bonuses etc) into superannuation for your retirement.  The government also incentives you through tax breaks to contribute more.  If you earn more than $37,000 before tax you can reduce the tax you pay through contributions to superannuation.  However you should remember that if you contribute this amount then you will not be able to touch it until you retire.  It is important to remember the above because tax should not drive your investment decisions but should be part of the decision making process.

You may have heard the term 'concessional contribution' quite often though asked the question 'what is a concessional contribution?' or 'how do concessional contributions work?'.  The concessional contribution is the amount of money that you can put into super in a given year that is taxed at the 'concessional' rate of 15%.  In 2011 / 2012 this is $25,000 if you're under 50 and $50,000 if you're over 50.  Note that this includes the amount that your employer is contributing to your superannuation as well as any benefits they pay for you through super (e.g. life insurance).

If you earn $100,000 (pre-tax) you're employer has to contribute $9,000 towards your super.  This means than you can contribute an extra $16,000 (pre-tax). 

• At this wage you would be in the 37% tax bracket
• The tax on the $16,000 would be $5,920 ($16,000 * 37%)
• If you salary sacrificed this into super you would only pay $2,400 in tax
• You would therefore be $3,520 better off

If you earn more than this (or are over 50) the potential benefits are even better!  Always keep in mind though that this money is not available to you until you retire. 

Beware the pitfalls

One thing you need to be aware of is that technically your employer can use the amount you salary sacrifice to complete their obligations (i.e. they are screwing you) so you need to amend your employment contract to ensure that any amount you salary sacrifice is after the amount they contribute on your behalf