Strategy: Use a Year of Low Income to Save Tax

Strategy: Use a Year of Low Income to Save Tax


Sometimes people may stop working for a year or so and have no income, or even negative income if they hold property. Not using the tax free threshold of approx. $20,000 is a waste in these situations. If you could use the threshold by generating income of $20,000 you could possibly save tax in future years.


Example 1

X is a high flying worker on $200,000. On 30 June he stops working and goes on a world trip. He comes back on 01 July the next year and goes back to earning $200,000.



If X could divert $20,000 from the second year to the first year he could possibly save around $10,000 in tax.


Example 2

Y has quit her job and has started a business. She doesn’t expect to make a profit in the first year, or even the second year because of the large start up costs and the time it takes to find customers and build the business up.


Shuffling income around is not easy to do, but here are some ways it could be possible.

a) Prepay expenses

Preapying expeneses is possible on investment properties, including interest. Interest on loans used to acquire shares could also be prepaid. Business expenses can be brought forward too – think about all those Office Works ads at the end of June each year.

Prepaying will bring forward deductions (where done correctly) and result in a higher income the following year.


b) Related Companies paying Wages

Where self-employed and operating through a company have the company pay you when you want.


Example 3

X has quit his job as an IT consultant and set up a company to do property management. The first year the company has a lot of expenses and little income as it is starting out. Its taxable income may be nil and X may be living on his savings. X could cause the company to pay him a wage of $20,000 – even though there is no income. This wage will be a tax deduction for the company and income to X. If the company doesn’t have the capital to pay a wage it could borrow to do so.


Even though the company has no income it may incur a loss which can be carried forward, under certain conditions, to future tax years. This will help save tax in those future years. At the same time X is on little to no other income so any wage he gets from the company will be taxed very low or even nil – but keep in mind the superannuation issues.


c) Lend money – spousal loans etc

The person without an income could lend money at interest to other related parties, under certain conditions, and there could be some tax benefits to the borrower in claiming the interest and the lender in receiving income – which they may not pay tax on.


Example 4

X has $500,000 in a term deposit earning ‘didly squat’ (bugger all). He could take that money and lend to Mrs X who has a $500,000 investment loan at 5% with ABC bank. X might charge the Mrs 4% and he receives an income of $20,000 and pays no tax.


Or


Example 5

X could lend Y that same $500,000 at 7% to buy another investment property. X may pay something like $3,347 in tax.

If Y was on the top marginal tax rate Y could claim $35,000 in tax and possibly save around $16,000 in tax.


d) Realise Capital Gains

Having assets pregnant with capital gains means asset sales could be done to realise these gains without paying tax, or minimal tax.


Example 6

X has a negative geared property and also a share portfolio with considerable capital gains. At the moment the dividend income is being offset by the loss from the property so that the taxable income is still $0. X could sell say $100,000 worth of shares with a $40,000 capital gain. This gain could be reduced to $20,000 with the 50% CGT discount and no tax payable. X could then rebuy back the same shares (or others). The reason to do it is to crystallise part of the capital gains now so that in the future when the shares are sold there will be less of a tax problem then – it also helps in using the 50% CGT discount now in case it is removed later.

Tax and financial advice should be sought before doing this.

This could also be incorporated into a Recycling Debt strategy.



e) Spousal Sales

With property the transaction costs are generally too high to want to crystallise capital gains just to save some tax. But where you could benefit from a restructure you might as well do it when the income is at the lowest point.



Example 7

X has an investment property with a low LVR and a main residence loan which is high. X has been considering the spousal sale strategy and now that he is off work for a year to study his lifelong passion of painting – on HECS – he wants to sell the investment property to his husband Y. X would pay less CGT when on the low income.



f) Combining Spousal Sales with Spousal Loans

Continuing the above example.

From X’s sale to Y X receives more than enough cash to pay out the loan on the main residence. He has say $100,000 cash left over. If the circumstances are right X could now lend Y this $100,000 and Y could use it as deposit on an investment property. Perhaps this could be done during the 2nd year of X’s painting course as the sale would have pushed his income way up.


All of these strategies are potentially high risk from a tax scheme point of view so careful tax advice is needed before trying any yourself.

 

A question on the prepayment of expenses. Isn't the aim to increase taxable income in the current financial year (low income) and decrease next year's (high income) ?
I could be missing something

 

I have pretty much done this in this financial year, more involuntary though than on purpose. I was unemployed after losing my last job so I went on the New enterprise scheme to start a business. I have got this for the last 9 months about $530 a fortnight to pay for basic expenses and it finished recently (now applying for Austudy). I lived in my property I ran the business in. I could claim 25% on expenses. I then sold my property just recently before the end of the tax year and the market in Newcastle has been peaking. I do not have to pay any CGT or very little as I lived in this place for last 2 years I moved in for 3 months in 2012 as well to renovate before renting it out again (it pays to move in when you buy or as soon as possible) . My business has not generated much income this year but should start in the next financial year. Then I will offset some of that by buying another IP next year etc etc...

I don't think there is much point buying any assets including, vehicles, computer upgrades till July 1?

 

Any strategies for splitting capital gains across income years when disposing of property? For example, if a property is in your name can you transfer half to your spouse and crystallise only 50% of the capital gain? The thinking there is that if the property was sold in a year or two, then you would only be liable for 50% of the capital gain and your spouse would have negligible gain or loss (since they only held it for a short period of time).

 

The aim is to shift income from the higher year to the lower year of income. So you would only pre-pay expenses in the lower year.

 

Yes, but would the stamp duty and the hassle be less than the CGT saved?

 

If doing this and self employed could it affect being able to borrow?
Ie- if 1 year is 200k then 20k the next yr and then back upto 200k 3rd year

 

Yes it certainly would effect borrowing because the income is changing.