Strategies for reducing your clients' tax bills

Troy Smith takes a look at tax issues and asks whether there is a way to wrench a few dollars back into your client's pocket?

The onset of the new financial year has brought an increase in some tax offsets, and both the capital gains tax (CGT) cap and low rate cap received a bump up.

For those of us who do not enjoy sending a slice of our hard earned dollars off to the taxman, the question begs, when do you start paying tax on income?

Tax offsets and other tax concessions allow low income earners, older Australians and small business owners to reduce the amount of tax they pay.

Low income earners can access the low income tax offset while older Australians may qualify for the senior Australians tax offset and the mature age workers tax offset. Small business owners can benefit by accessing the small business concessions and by contributing for their retirement.

Low Income Tax Offset (LITO)

Resident taxpayers with income below certain thresholds are entitled to the low income tax offset. For the 2010-11 financial year, the maximum rate of LITO is $1,500, up from $1,350 last financial year.

Adult taxpayers can earn up to $16,000 tax-free while minors can receive up to $3,333 in unearned income, tax-free.

Resident taxpayers with taxable income less than $30,001 receive the maximum rate of LITO. However LITO reduces by four cents for every dollar of taxable income, which exceeds $30,000 until phasing out completely when taxable income reaches $67,500.

The thresholds for LITO are shown in table 1.

Any unused LITO cannot be received in cash, nor transferred to a spouse or carried forward to future financial years.

Senior Australians Tax Offset (SATO)

The senior Australians tax offset is available to age pensioners and self funded retirees over age/service pension age who meet certain income requirements.

No tax is payable for single people who earn income of up to $30,685 while couples are not taxed on incomes of up to $53,360 ($26,680 for each member of a couple).

The maximum amount of SATO for a single person is $2,230 provided their income is under $30,685, while each member of a couple receives $1,602 in SATO if their income is under $26,680. SATO shades out when income exceeds these thresholds, with a reduction of 12.5 cents for each dollar above the threshold.

The cut off threshold, where no SATO is paid, is $48,525 for single people and $39,496 for each member of a couple.

Unused amounts of SATO may be transferred to an eligible spouse, provided that both members of the couple are eligible to receive SATO. Any unused amounts that aren’t transferred are not refundable.

SATO has been around for a number of years but advisers need to be aware that the definition of income, which used to determine eligibility changed in July 2009.

SATO is based upon rebatable income, which includes taxable income, total net investment losses, adjusted fringe benefits and reportable super contributions.

Mature age workers tax offset (MAWTO)

MAWTO provides working individuals aged 55 and over with a maximum tax offset of $500. The offset that has remained the same for the 2010-11 financial year provides qualifying individuals with the opportunity to hang on to a few more dollars, see table 3.

Eligible taxpayers can earn up to $19,333 without paying tax when you take into account MAWTO and LITO.

MAWTO can be used to offset any taxation liability to nil, however any unused tax offsets are not refundable.

Net income, for the purposes of MAWTO, excludes a variety of income sources including social security benefits, dividends, capital gains, rental income, employment termination payments or superannuation pension income.

Case study: Rusty

Rusty is a widowed 70-year-old engineer who would like to reduce his working hours from full time to part time. He is able to meet his living expenses from his tax-free account based pension, but doesn’t want to pay any tax on his income generated from employment.

Rusty can earn up to $32,271 of income tax free as seen in table 4.

The objective of this case study is to hammer home the message that the combination of all three tax offsets can provide up to $32,271 of income without paying any tax.

Low rate cap

For those under 60 years of age, lump sum withdrawals from super may be taxable. While the tax-free component is received tax-free, the taxable component (element taxed) is also tax-free if the withdrawal is within the low rate cap. Withdrawals above the cap are concessionally taxed at a maximum of 15 per cent.

The low rate cap is $160,000 for the 2010-11 financial year, which is a $10,000 increase on last year’s cap, see table 5. However the low rate cap applies if you have reached preserved age.

The cap operates by applying a tax offset to ensure that the correct amount of tax is applied, subject to the threshold. Irrespective of whether withdrawals are included in the low rate cap or not, the taxable component of lump sum withdrawals is included in the assessable income of the taxpayer. This means that an individual may lose some tax offsets (such as LITO or SATO).

Small business CGT concessions and the CGT Cap

The small business CGT concessions allow qualifying individuals to disregard all or part of a capital gain from disposal of certain assets.

Of the four small business CGT exemptions available, only the 15-year exemption and retirement exemption proceeds may be contributed to superannuation.

This provides an opportunity for qualifying individuals to tax effectively boost their retirement savings, but how does it work?

The small business 15-year exemption allows eligible individuals to disregard any capital gains arising from disposal of certain assets, qualifying shares in a company or interests in a trust.

The small business retirement exemption allows an entity to disregard a capital gain up to $500,000 if certain conditions are met. The amount of $500,000 is an individual’s lifetime limit, which is unindexed.

For those who meet the criteria to disregard a capital gain by applying the small business 15-year exemption, an amount equal to or up to the capital proceeds can be contributed to superannuation as a CGT cap contribution, subject to the CGT cap limit.

For the financial year ending 2010-11, the CGT cap contribution limit is $1,155,000. The CGT cap is a lifetime limit, which is indexed annually.

For those who disregard a capital gain by applying the retirement exemption, only an amount equal to the capital gains can be contributed to superannuation, subject to a lifetime limit of $500,000, which is unindexed.

Contributions made under the CGT cap do not attract contributions tax. As these contributions are tested against the CGT cap, they are not assessed against other contributions caps (such as concessional or non-concessional caps).

Before any contribution is made to superannuation, advisers should consider if a client is eligible to contribute to superannuation.

Those who are under 65 years of age are able to contribute to super, while those above 65 years of age but less than 75 years of age are required to meet a work test before a contribution is made.

Those above 75 years of age are generally unable to contribute to super. The same rules apply to CGT cap contributions.

Summary

Tax offsets provide an opportunity for your clients to reduce tax or even eliminate paying tax.

Resident taxpayers can earn up to $16,000 while those eligible for MAWTO can receive up to $19,333 tax-free.

Seniors can earn up to $26,680 (each member of a couple) or $30,685 (single).

The low cap rate allows those who are above preservation, but below 60 years of age, to receive tax concessions or eliminate paying tax on lump sum withdrawals from super.

The 15-year small business concession allows qualifying individuals to disregard any capital gains from the disposal of eligible assets and contribute up to $1,155,000 to super.

While the small business retirement exemption allows qualifying individuals to disregard up to $500,000 of capital gains from the disposal of eligible assets and contribute the same amount to super.

In such taxing times, it must be good to have a few levers in an adviser’s toolbox, to provide a good news story to clients.

Troy Smith is a technical specialist at ING Australia.