Week 4 Topic 8 Tax Planning Strategies Flashcards
Income Splitting
- Transfer of income from an individual at higher marginal tax rates to one at lower marginal tax rates.
- Income from business activities only can be split
- Income can be transferred through the transfer of assets or investments to individuals at low marginal tax rates.
- Some tax consequences that must be considered are: transfer of income to a child as unearned income, the actual payment of income may be required, transfer of assets may give rise to CGT.
Income Versus Capital Growth
An investment may provide income or capital growth or both
Investment preferences depend on clients cash flow needs and investment time horizon
Income earned from an investment is assessable
Capital gains tax, however, may be taxed at a concessional manner.
Individual sole ownership
Advantages:
- Salary packaging
- Splitting of investment income
- Main residence exempt from GST
- 50% discount on capital gains
- Tax-free threshold and grated tax scale
- Domestic losses carried forward
Disadvantages:
- Not possible to spit salary or wage income
- Minor subject to a penalty tax
- Marginal rates climb to 45%
- Medicare levy/surcharge at certain income levels
Partnership
Advantages:
- Capacity to split income
- Capacity to direct assets and or income to partner with lower taxable income
- Losses are distributed to partners to offset against other income
- Relatively simple to administer
Disadvantages:
- Minor subject to a penalty tax
- Marginal rates climb to 45%
- Medicare levy/surcharge at certain income levels
- No flexibility in sharing income as fixed according to the partnership agreement
- Can share income as the percentages are fixed in the original partnership deed. Year after year it stays the same
- Can not stream income, meaning change the split year after year. Percentage sharing is fixed
Companies
Advantages:
- The flat tax rate at 30%
- Normally, losses can be carried forward
- No requirement to distribute company earnings to shareholders
- Personal asset protection
Disadvantages:
- No tax-free threshold
- Losses are kept within the company
- No concession on the calculation of CGT
- Costs of administration
Trusts
A trust is created over property or income is a fiduciary obligation imposed on a person (trustee) to hold property or income for the benefit of other persons who may or may not include the trustee.
- Governed by a trust deed, which sets out the various rights and obligations on the operation of the trust.
- Trust structure can own and hold assets and investments, or run a business
- Controlled and managed by the trustee, for the benefit of the beneficiaries ie. trust has legal ownership
Discretion Trust VS Unit Trust
Discretion trust:
Discretionary trusts are when the trustee chooses which beneficiaries receive the trust property, and how much of the trust property they get. The discretion is in the trustee having the option of splitting up the trust property however they like.
Unit trust:
Unit trusts are fixed, express trusts. Unlike discretionary trusts, unit trusts allocate the shares in the property for beneficiaries in the trust agreement, rather than discretion by the trustee. Each beneficiary is allocated a unit in the trust property beforehand.
Trust Advantages and Disadvantages
Advantages
- Capacity to direct income to beneficiaries with the lowest marginal tax rates.
- Can stream income e.g. percentage of benefits can change year to year
- 50% discount on capital gains
Disadvantages
- No main residence exemption
- Losses are trapped inside the trust and can be offset only against the future trust income
- Costs of administration
Superannuation funds
Advantages
- 15% tax rate on earnings
- Possible reduction of capital gain by one third
- Upon retirement the removal of income tax and capital gains tax
Disadvantages
- Investment restrictions
- Restrictions on borrowing
- Costs of administration
- Funds cannot be released until a condition of release has been met
Negative Gearing
Arises where total deductions associated with an investment exceed the assessable income generated. Loss can be used to reduce income from other sources such as salary and wages. An investor may be willing to generate a tax loss each year as long as there is the potential to generate capital gains.
- Gearing: borrowing money
Daryn has a taxable income of $100,000 excluding income and expenses associated with a rental property he owns. Daryn also earns $15,000 in rent and incurs interest bill $12,000 (on the loan used to buy the property). He also incurs maintenance costs of $3,000 and is allowed to claim a depreciation allowance of $2,000. (Ignore the impact of LMITO).
15,000 - (12,000 + 3,000 + 2,000) = -2,000 (loss on property)
100,000 - 2,000 = 98,000 (taxable income)
(98,000 - 90,000) * .37 = 2,960
2,960 + 20,797 = 23,757 (tax payable)
98,000 * 2% = 1,960 (medicare)
23,757 + 1,960 = 25,717 (net tax payable)
If Daryn did not own rental property
Taxable income = 100,000
3,700 + 20,767 = 24,497 (tax payable)
100,000 * 2% = 2,000 (medicare)
24,497 + 2,000 = 26,497 (net tax payable)
The difference:
26,497 - 25,717 = 780 Tax shield (2,000 * .39)
Salary packaging and remuneration planning
Salary packaging is an arrangement by which an employee agrees to forego part of their salary or wages in return for their employer providing non-cash benefits of similar value.
Total employment cost
The actual amount paid for all employee wages and benefits.
From an employers point of view, it must not increase TEC
From an employees point of view, it should not decrease TEC
Overpackaging can lead to less super paid to employers
Fringe Benefit Tax
Employers must self assess the Amount of fringe benefit tax they have to pay for hen lodging their FBT return at the end of each FBT year on annual payment summaries if they are above the threshold level.
FBT is determined under the following process:
Determine the taxable value for the benefit
Apply a gross-up rate
Apply FBY rate of 47%
Two types of benefits that can be paid
Type 1 benefit:
It is a type 1 benefits If employer can claim GST input tax credit under the GST scheme.
Has a gross up factor = 2.0802 (based on 47%)
Type 2 benefit:
This rate is used where there is no entitlement to a GST credit.
Gross up factor = 1.8868 (based on 47%)
Four categories of Fringe Benefit Tax
Fully taxed fringe benefit:
