An effective way to reduce tax payable is to make concessional (deductible) contributions to superannuation.
For an employee, this generally requires salary sacrifice to be arranged with the employer in ad vance of the income being earned. The arrangement may need to be set up early in the financial year to gain the maximum effect.
A self-employed person can choose to claim a tax deduction for personal contributions made at any time before the end of the financial year. Non-working clients (for example, unemployed, home makers or retired clients) who do not receive any salary as an employee during the year can also claim a deduction for personal contributions. Employees are only eligible for a deduction if they meet the 10 per cent rule.
CALCULATING THE TAX DEDUCTION
All personal contributions are first classified as non-concessional contributions when received by a superannuation fund. The status is only changed to a concessional contribution if the person notifies the trustee of the intention to claim a tax deduction using a Section 290-170 notification form.
The client can choose how much of the con tribution they wish to claim as a tax deduction. To ensure tax is minimised, the client’s total situation (after allowing for the 15 per cent contributions tax) should be assessed, not just personal PAYG tax.
The tax calculations should balance the rate of PAYG tax saved against the tax paid on conces sional contributions. Assessable income should generally only be reduced if the personal tax rate on a dollar is more than 15 per cent. Reducing assess able income further can result in the client paying more tax than is necessary unless the reduction gives further access to other benefits or concessions.
Calculations should take into account the use of the tax-free threshold and offsets such as the low income tax offset, the mature age worker offset and the senior Australian tax offset.
Clients should always be referred to their tax adviser to do the final calculations and find the op timal position. However, it is important for finan cial planners to understand the taxation concepts and the issues relevant for calculating the balance.
CASE STUDY – OPTIMISING THE VALUE
Wendy is age 66, single and retired. She was employed for a short period during the 2008-09 financial year. Wendy’s income position is:
*Franking credit received for cash dividend of $6669
The capital gain relates to an asset held longer than 12 months, so 50 per cent of the gain is excluded from assessable income. Wendy has total assessable income of $86,983 and a potential tax liability of $22,098 (including Medicare).
Wendy met the work test to be eligible to con tribute to superannuation so she contributed the full capital gain of $149,554 into superannuation before June 30, 2009.
When considering her tax planning, two ques tions arise:
*Can she claim a personal tax deduction for the contributions?
*If yes, how much should she claim as a tax deduction?
ELIGIBILITY FOR TAX DEDUCTION
Wendy was an employee for part of the year so she needs to meet the 10 per cent rule to claim a tax deduction. She can easily satisfy this rule as assess able income from employment is only 3.04 per cent of her total assessable income.
Wendy has a concessional contribution limit of $100,000 but this includes any superannuation guarantee (SG) contributions paid by her employer.
OPTIMISING THE TAX DEDUCTION
Concessional contributions are taxed at 15 per cent in the super fund. Therefore, a tax advantage is only gained from a deduction if her effective mar ginal rate of tax on each dollar claimed as a deduc tion would have been higher than 15 per cent.
In most cases, the optimal position for a client is to reduce assessable income to the point where the 15 per cent tax rate cuts in, after allowing for the use of tax offsets.
If Wendy claims a tax deduction of $86,983 to reduce assessable income to zero she will receive a tax refund of $3072 ($2837 franking credit plus $235 PAYG tax deducted from salary).
However, $13,048 tax will be deducted from the deductible portion of the contribution.
As an alternative, Wendy could claim a tax deduction sufficient to reduce taxable income to $29,347. This makes full use of her eligible offsets to reduce personal tax to nil.
*Medicare levy is ignored as the 2008-09 concessional thresholds for senior Australians are not yet known. These figures will be advised in the 2009 Federal Budget. In 2008-2009 Wendy would have paid some Medicare if taxable income exceeded $25,867.
This option requires Wendy to claim a tax deduction of $57,636. She still receives a full re fund of the franking credits and PAYG tax already deducted ($3072) but the tax on contributions is reduced to only $8645 – a tax saving of $4403.
The scaling back of the senior Australian tax offset starts to impose an effective tax rate for Wendy of 32 per cent (plus Medicare) at taxable income higher than $29,347. At lower levels, the offsets are not fully utilised.
ESTATE PLANNING IMPLICATIONS
Selecting an appropriate level to claim as a deduction has tax advantages for the year of the contribution. It can also minimise the amount of tax paid on a death benefit that is paid to a non-death benefits dependant, such as an adult child.
The amount of the contribution that is claimed as a tax deduction is added to the taxable compo nent of the superannuation benefit. Tax of 15 per cent (plus Medicare) is payable if paid as a death benefit to a non-financial dependant. The non-de ductible portion is added to the tax-free component and is paid tax-free.
In the example of Wendy, she is single and does not appear to have any death benefit dependants. The decision to claim a deduction of only $57,636 could also reduce the tax on a death benefit by $4402 compared to the higher deduction of $86,983.
Calculating the optimal position is an indi vidual calculation as it depends on the client’s situation and the offsets or other concessions that they become eligible for. The example in this article provides an optimal position for Wendy based on her circumstances.
Each client may have a different outcome based on their own circumstances and professional taxa tion advice should be obtained.
The 10 per cent rule
A person who works as an employee during the year can choose to claim a tax deduction for personal superannuation contributions if they meet the 10 per cent rule for that year.
Under the 10 per cent rule, assessable income (plus reportable fringe benefits) from employ ment must represent less than 10 per cent of total assessable income plus fringe benefits.
If this rule is satisfied, the person can choose to claim a tax deduction for personal contributions made by providing a Section 290-170 notice of intention to claim a tax deduction to the trustee of the superannuation fund. This notice must be provided before:
*the tax return is submitted for that financial year, or
*the contributions are used to start an income stream, or
*the contributions are split with a spouse.
If the person is over age 65, they must be eligible to contribute to superannuation (that is, have worked 40 hours within 30 consecutive days) before making any contributions.
Louise Biti is director of Strategy Steps – www.strategysteps.com.au