Tax Tip 284: How a couple could earn more than $87,500 per year and pay no income tax

How a couple could earn more than $87,500 per year and pay no income tax?

Easy!

In the thread:

Tax Tip 197: How much can be earned without having to pay tax?

Tax Tip 197: How much can be earned without having to pay tax?

I pointed out that a resident individual could earn up to $21,885 and not have to pay any income tax.

If this income were solely from capital gains to which the 50% CGT discount applied that would mean they could earn twice this and not pay income tax.

That would be $43,770

If there was a couple each with this income that would be $87,540 per year


If a couple had the main residence fully paid off this would be a great level of income to be able to live on in retirement.


One way to manage your affairs to be able to do this would be to set up a discretionary trust with which to invest in. This will provide flexibility in case there is income from other sources. It would also add opportunities when the children reach 18 and are not earning an income.

It would be relatively easy to manage where the trustee invested in shares that do not pay dividends. But it could also be managed if there is dividend income as well, but the level of total tax free income would lower.


Example

Marge and Homer have a paid off main residence and want a pre-tax income of $100,000 per year. Marge is currently not working, and Homer earns $100,000 per year before tax and they are living fine on this while putting a lot away for investing.

The after tax income that Homer gets is $74,282 because the tax he pays is $24,717.

For many years they have been investing in shares that pay bonus shares instead of dividends (they also have some share that pay dividends as Marge don’t work).

The level of shares they hold is enough to implement this strategy so they work out the plan by finding out the cost base of the shares and calculating how much they would need to sell to generate $87,540 in gains in the trust.

They sell those shares during the year, at the right moment, but not right at the end as they want to check the figures, so they don’t need to pay any tax.


This strategy could be combined with other strategies too such as borrowing against the house to invest allowing for interest to be deductible giving a greater amount of capital gains that could be produced without tax – but the interest would only be deductible if there was dividends.

 

For 2023/24 an individual resident taxpayer could earn up to $21,884p.a. and not pay any income tax.
So this means an individual could potentially earn twice this in capital gains that have the 50% CGT discount and not pay tax, i.e. $43,768

For a couple this would be $87,536 per year, combined, potentially tax free income

 

And franked income could also differ and may elevate the point at which tax does become payable. While the franking credits also add to assessable income they are refundable up to a point. This can cover the tax on apparent assessable income. eg In the example given by Terry if joint income is say $21,800 each then this may actually be higher if its franked. eg $9342 of franking pushes assessable income to $31,142 each. This leaves $2382 due each. But the franking credits cover that ...with a further $6960 refund (each).

Eg each of a couple could EACH have $50301 of franked income. ($35211 of divs) and tax of $7575 is payable. But franking covers this with $7515 also refundable. So if that couple chased even higher dividend income of say $63000 (with 18633 of franking) then tax is $12147 with $18633 of franking to cover that tax and still get a refund of $6486 each. Unfortunately this doesnt maintain.....Above $80K this tapers off quickly as the marginal tax rate chews up the refundable part. But $160K "tax free" isnt too shabby.

A rule of thumb is the the cash div may be 70% of the taxable income and 30% is franking. Or the assesable is divided by 1.42 to give the cash div target. And beware of unfranked divs.

Its also possible in some cases to contribute to super to pull income under threshold too ....But beware of the 10% rule...... If a person can contribute a deductible contribution they can elevate their refundable franking for a tax benefit

This issue can also be a great benefit of disc trusts provided they have a family trust election. Each individual beneficary can maximise their franking use and then a company beneficiary can then be considered. Catch to this is a company gets no franking refunds however. The franking can cover company tax which may also be at a 30% rate meaning no extra tax. If you invest in joint names its a fixed and limited choice to the matter