Tax Tip 147: How to Earn $95,000 pa and pay No Tax

Tax Tip 147: How to Earn $95,000 and pay No Tax



Franked Dividends are the key.



If the dividends received are fully franked this means the company has already paid tax on the income and a credit is received by the recipient of the dividends for this.



The figures are:

$95,000 dividends Fully Franked

$40,714 in franking credits (95,000 x 30/70)

$135,714 in taxable income



$40,560.46 tax would be payable on $135,714 (2016-2017 financial year, including Medicare levy)

But $40,714 in franking credits have been received so there would actually be a refund of $154 received.



Example 1

X owns $1,900,000 worth of shares on the ASX which are yielding 5%.



Example 2

X owns shares in a bucket company which has been receiving distributions from a family trust and storing the money. X has been waiting until he quit his job before starting to draw down on these retained profits.

In either case X would have annual after tax income of $95,154 pa.

 

And if the share funds were borrowed? Margin loan rates are still pretty high.

 

That doesn't really change much - just a higher amount could be received because the interest would be deductible.

 

The example is very misleading. No ADDITIONAL tax is paid in the example given. This scenario is very different in almost every case:
1. Taxpayers earns $60,000 salary and lets assume that 100% of the tax on the $60K has been paid though withholding. My calcs indicate a additional $12670.86 is payable representing a tax rate of 51.11% on the dividend. If the taxpayer earns more that tax rate can also be higher.
2. The scenario assumes a company receives a dividend through a trust distribution. There can also be instances when the taxpayer is denied some or all of the franking credit if the trust produces share trading income. The tax position of the shareholder must be considered. eg If they are non-resident then NO tax is payable by them but all credits are lost. Cant be fixed and since a dividend was declared and paid it cant even be unwound. Its not a rare issue. I have seen plenty buy shares just prior to a div and take the div and sell the shares down too soon meaning the tax credits are lost. (45 day rule)
3. The term "bucket company" often describes a situation where trust streams to a company for the benefit of a lower tax rate. The strategy around trust to company is often undertaken for two reasons 1. Deferral, 2. Lower rate. Where 2. alone is the reason then a concern generally happens. This low rate is an illusion in some instances. If the company lends the proceeds or the shareholder/ directors use the proceeds there can be serious tax outcomes that prevail over the apparent fully franked dividend. Loss of franking credits could occur too.
4. There can also be strategies for obtaining a substantial refund of the franking credits. eg Taxpayer receives a FF dividend and then makes a deductible super contribution, uses tax losses etc. Strategies of then drawing pension (tax free) from fund etc mean taxpayer earns good income stream but pays no tax - Even gets refunds.

A benefit of using FF dividends is that taxable income is grossed up. ie Taxable income is not $95K but $135K. This can appear favourable to lenders. However, they will then assess the income derived from the trust activities as related party income and this can be difficult and complex and recurring income can be bought into question.

All reasons to consider advice and prudent tax planning.

 

i should point out that I wasn't taking into account other hypothetical what ifs
- no other salary orincome
- loan division 7A loans
- no non resident issues

Just pointing out that a person (who is a tax resident), perhaps in retirement - or at least not working - could earn $95,000 pa and not pay tax.

Paul's comments are like saying the tax on an income is $20,000, but it is not if the guy earns $40,000

 

If retired, wouldn't one be better off owning the $1.9M of shares in their SMSF because they get the $95,000 tax free and have asset protection.

They (assuming a couple) could also earn $36,000 outside super (from property and/or part time work) and still pay no tax.

That would generate $130,000 tax free.

 

If retired before retirement age, can you own the shares in your own name to access the income, then set up a smsf close to retirement age to access the tax benefits and transfer the shares over?

 

Yep they would.
But not always possible.

 

You could do something like that, but you would be up for CGT and there are limits on contributions to super.

 

No. The SMSF cannot own shares in a related party entity as the shares are currently woned by a related party. s66 prevents that acquisition unless they are LISTED shares tfr at market. (There is a 5% limit also if that was not a issue). Seek financial advice before doing this

If retired there may be no additional tax benefit using a SMSF v personal ownership.

 

To be fair, @Terry_w did make it clear that X has been waiting until he quit his job before starting to draw down on these retained profits. From that point of view I didn't find it misleading. You raise some excellent points though, which highlights why people should seek proper advice before attempting anything like this.

Would this not depend on the age of X? This might work if X is under 65 but if aged 65 or over, then X must satisfy a work test if X intends to make super contributions. If X is aged 75 or over then X cannot contribute to a super fund at all, as far as I know.

So someone could read your post and think they can stream their FF dividend income into super but that may not be the case if they are aged 65 or over (must satisfy a work test) or 75 or over (cannot contribute to a super fund at all).

Definitely agree.

 

The work test ? Its gone...Super laws were give Royal Assent on Monday and a completely new regime starts on 1st July 2017. ALL taxpayers will be able to make deductible contributions. IMO it a new regime for salary sacrifice. Provided you havent blown the $1.6m cap its on for all.

 

That's great news! Does it apply to people over 74 though?

If you’re aged between 65 and 74, the good news is that from 1 July 2017, you no longer have to meet the work test (i.e. the requirement that you work 40 hours over a consecutive 30-day period before you can make a contribution).

This means it will be easier for older Australians to increase their retirement savings, in particular from sources that may not have been available to them before retirement – this includes proceeds from the sale of a property.
​

Key changes to superannuation | Federal Budget 2016 - StatePlus

 

Got to watch out for the superannuation contributions caps and balance limits. You would need advice on whether the above arrangement is within the rules.

From 1 July 2017, the Government will lower the annual non–concessional contributions cap to $100,000 and will introduce a new constraint such that individuals with a balance of $1.6 million or more will no longer be eligible to make non–concessional contributions.
​

Request Rejected

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I was assuming the $1.9M of shares was held by a couple. So, $950K each should be OK .

 

Thanks Paul, can you please explain this? I thought income in smsf is tax free and therefore tax paid is refundable to the taxpayer? Thanks

 

Not all people can put more $ into super. Heaps of clients hold some additional $ outside super as they have a $24K or better tax free threshold in any event so its still 0% tax. Super isnt always the right choice. For a couple they can earn $48K combined. From 1/7/127 they will be able to make a tax deductible contribution to super. Thus their taxable income could be even lower....tax credit refunds . Happy days. It can be cyclical too where the $ come from super and it funds the contribution to save tax....Depend on tax rates etc. Ideal target is to get taxable income to around $24K. This maxes the refunds of franking.

All strategies depend on individuals. eg someone on a small pension wouldnt want to earn large $ outside super.

Also why a SMSF. Any fund can do this.

 

@Terry_w if I wanted to run this as an annual payment, how much would my investment company need to earn per annum? I was thinking roughly $150k

My company owns $2,150,000 of Vanguard EFTs returning 7% ($150,500 annual income)
My accountant would charge around $5k for advice, business activity statements, annual return and company tax return
My company pays tax of $43,650
After tax, my company is left with ~$100k
My company issues me $95,000 in Fully Franked dividends.

Is this approximately correct?

 

For $5,000 per year this is something your accountant should be answering.

if you wanted $95,000 income pa then your company could pay dividends of $95,000 plus franking credits. The tax is paid for by the franking credits basically.

This doesn't mean the company needs to be receiving $95k in dividends per year - it could have retained earnings from previous years.

 

I haven't set up the company yet. I'm just pre-planning and writing down all the questions so I can get most of the questions sorted in one visit.