I spent lunchtime at work sorting out what stocks had been sold during the last financial year, and it turned out that they'd only been a handful of them. Unfortunately two of them didn't have complete information in my capital gains transactions log (I only started back-filling all the missing data earlier this year). This meant that I had to wade through the paperwork files for my past seven returns this evening to find the information relating to DRPs over that period.

When I checked with my dad this evening he told me that his accountant hadn't been able to complete the tax return for the farm partnership, so I'll probably have to use an estimate when I lodge my return, and then lodge a ammendment request later on when the correct figure is known. This is a nuisance as my taxable income also has to be reported on DW's tax return as it affects the calculation of any family tax benefit she may be entitled to.

I didn't get my tax return completed this evening. I still have to work our the capital gain made on one US stock holding (in my "Little Book that Beats the Market" portfolio). And I also haven't pulled together all the income and expenses data for my sole trader business (it started out as a website design business but these days most revenue comes from this blog ie. not much). Which reminds me - once I've finished my tax return I also have to lodge the annual BAS statement for my "business". I'm having a day off work on Friday, so I'm hopeful that I'll be able to get everything finished off that day. If I'm really lucky dad's accountant might have the partnership tax figure ready by then. I'll probably have to pay a $110 fine for lodging a late tax return, but there won't be any penalty interest as I expect to be due a small refund (due to our rental property being vacant for a few months last Christmas time). Hopefully there won't also be a fine for DW's late return or my overdue BAS statement...

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Enough Wealth 2007

I took a day of annual leave today - in theory to have some quiet time while DS1 was at school to sort out my paperwork for my tax return. I didn't get as much done as I'd hoped - I had to call ps146 in the morning to do a "role play" assignment via telephone as part of the DFS(FP) course I'm doing, so I didn't get started on sorting and filing until after lunch. And then DW had to go to the school early in mid-afternoon to collect DS1 as he had a bit of a chest cold which had triggered an asthma attack. He had a mild temperature (~1 deg) when he got home, but he seems OK this evening. He's still a bit wheezy and having puffs of Ventolin every few hours, but hopefully going to bed early and a good night's sleep will seem him better by morning.

Anyhow, I did manage to add up all the interest payments I'd received last year. Aside from a couple of joint accounts (where I have to include half the interest on my tax return, but the accounts are actually used exclusively by DW these days) I had a total of nine interest bearing accounts in use last year. A couple of them are linked to my margin lending accounts, and some were online accounts used to earn interest on my 0% CC balance transfer arbitrage activities. All together I earned a total of $1,783.98 in interest last financial year. I'll probably end up paying 30% income tax on that interest. Although I had various tax deductions (superannuation salary sacrifice, margin loan and rental property interest) to reduce my taxable income, I also received some unplanned capital gains during the year due to takeover activity affecting my stock portfolio. I still estimate that my total taxable income will end up within the 30% tax rate band.

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Enough Wealth 2007

Medical expenses can consume a large chunk of ones cashflow, and also have tax implications. Firstly, medical insurance. In Australia there is universal public health coverage. A 1.5% medicare levy is charged based on your taxable income (there are some exemptions and reductions for special cases such as low income households) which contributes towards the cost of public health in Australia. There is also a medicare levy surcharge (MLS) of an additional 1% of taxable income is charged when your income is above the threshold and you don't have private hospital insurance. The threshold for an single taxpayer is $50,000 and varies for different family types. For example, DW and I have 2 children, so our MLS threshold is $101,500. In previous years when DW and I were both working fulltime we would have had to pay the surcharge if we didn't have private hospital insurance. So the monthly insurance premium of $144.20 was good value as it was close to what the surcharge would have cost anyhow. This year our combined taxable income will be a lot less (around $60,000) as DW is working part-time and also salary sacrificing around half of her wage into superannuation, and I am salary sacrificing around half of my wage as well. As the monthly insurance premium has increased to $151.45 we could save $1,817.40 by cancelling out insurance. We'd have to take up coverage again when DW resumes fulltime work. However, I don't think I'll cancel the insurance as it is very useful if you ever need "elective" surgery (otherwise you'll be on the public hospital waiting list, which can be very long).

The second tax aspect of medical expenses is the Net medical expenses tax offset. Net medical expenses are the medical expenses you have paid less any refunds you got, or could get, from Medicare or a private health fund. You can claim a tax offset of 20% – 20 cents in the dollar – of your net medical expenses over $1,500. There is no upper limit on the amount you can claim. For example, our total medical expenses on GP visits, specialist consultations and tests, pharmaceuticals, dental work and optical costs was $7,191 in the past 12 months. Our total refunds from medicare and our private hospital cover was $1,340 for this period, leaving us "out of pocket" to the tune of $5,851. This means I can claim a tax rebate of 20%x($5,851-$1,500) = $870.20, which is better than nothing. So it's important to keep all receipts for pharmacy, dental and optical expenses as medicare only has a record of the expenses that you claimed a refund for (mainly GP and specialist doctor and hospital costs).

Although it would be interesting to know the ratio of our health expenses to the benefit we've received from medicare and our private hospital insurance, it's not easy to calculate. For one thing the medicate levy only pays for part of the governments expenditure on public health. A larger amount comes out of consolidated revenue. Also, aside from the obvious medicare refunds that you have to apply for, there is an inbuilt subsidy for medicines via the PBS (Pharmaceutical Benefits Scheme) which isn't printed on pharmacy receipts.

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Enough Wealth 2007

In past years I've made investments into agricultural schemes. Aside from the 100% tax deducibility of the inital investment, ongoing annual management fees, land rent and insurance premiums are tax deductible each year. Eventually I'll hopefully get a reasonable return on these investments in timber (hardwood for wood chips and teak for sawn logs) and sandlewood (for incense). Although this sort of investment provides income tax deferral rather than 'converting' income into capital gains, it is still worthwhile as you get to benefit from the returns generated from the investment of the deferred tax amounts, plus tax cuts in recent years have meant that my marginal tax rates will be lowered when the investments produce income than would have been the case in the years when the initial investments were made. In addition I'll be able to use this income to help cover living costs in future years, so I'll be able to salary sacrifice more of my salary into retirement savings than would otherwise have been the case.

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Enough Wealth 2007

The next large deduction item on our annual tax return is the expenses for our rental property. As it is owned in joint names with DW, we work out the total deductible expenses using the ATOs worksheet for rental properties, and divide each item in half to include on each of our personal tax returns (Australia doesn't have joint filing, although many government benefits such as Family Tax Benefit are based on the combined income of couples). The deductions for rental properties are fairly standard, such as interest on the mortgage loan (make sure you don't include any amount of your payments that is actually principal repayment), cost of repairs, council rates, land tax, water rates and insurance. Some other expenses associated with purchasing a rental property (such as solicitors fees, loan stamp duty etc) are deductible for the first five years after purchase, with 1/5 of the total expense being claimed each year.

If you only had the property available for rent for part of the year (either bought it during the tax year, or had the property off the market for part of the year) you can only claim a pro-rata fraction of the expenses. The ATO also takes a dim view of claims for expenses where the property wasn't really available for earning a rental income. An example would be where a holiday property is used by the owner during the peak rental season.

Another trap to watch out for is claiming deductions for repairs that are actually improvements. Improvements can't be claimed as an expense, but are taken into account as part of the cost base of the property when you eventually work out capital gains when the property is sold.

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Enough Wealth 2007

Once all the income items have been completed it's time to get to work on itemising my deductions. The biggest one for me is the interest paid on the margin loans I've used to buy stocks for my share portfolio. I pay some interest up to 12 months in advance (in late June) to bring forward the tax deduction, and the remaining interest component is part each month as it accrues. My overall gearing level is fairly modest - around 50% loan-to-value ration (LVR), which corresponds to a debt:equity ratio of 1:1. As the interest paid on the margin loan is more than the dividends received, I get a net income tax deduction from my stock portfolio. Eventually capital gains tax will be paid on realised gains when stocks are sold, but, provided they've been held for more than 12 months before being sold, the capital gains tax rate is effectively half my marginal income tax rate (the actual calculation is to apply my marginal tax rate to 50% of capital gains).

Enough Wealth

One of the changes made in the change to "Simper Super" went relatively unnoticed until now. All the media attention was around Retirement account withdrawals being tax free for retirees over 60 under the new rules, and the last minute opportunity to contribute up to $1 million into super before the new contribution limits come into effect on 1 July. It's only now that people have started to realise that under the new rules you will be hit with a 46% contribution tax rather than the usual 15% tax on pre-tax contributions if you haven't given your TFN details to your super fund manager. You also won't be able to make any undeducted contributions into a super fund after 1 July if you haven't given them your TFN - which would mean you can't get the co-contribution.

The media seems to have bought the government line that this change is all to do with making it easier to find the owners of "lost" super accounts. I think it has a lot more to do with clamping down on tax avoidance - the fact is that there have been a lot more tax file numbers issued to individuals than really exist in Australia. In the early days it was possible to open bank accounts under false names (no 100 point worth of ID was required back in the early 80s), and it was also fairly easy for someone to get multiple TFNs when they were first introduced (often by using a copy of a birth certificate obtained for a deceased person). These extra TFNs (under false names) were used to avoid tax. I'm sure there are still quite a few people working multiple jobs and using a different TFN for each, thereby getting the benefit of multiple tax free thresholds and low marginal tax rates. Up to now each of these jobs would have paid compulsory SGL amounts into a super account under those same false names. If the TFNs are provided for these super accounts the data matching used to find "lost" super accounts could help identify where one person appears to have multiple TFNs in use. If a TFN isn't provided for an account it could be a trigger for the ATO to check if the account appears to be legit. At the very least the lack of a TFN would mean any future contributions into the account would attract the top marginal tax rate.

I'm amazed that anyone in the media has swallowed the line that the requirement for TFNs will be used to reunite "lost" super accounts with their owner. After all, if the owner knows about the account and provides the TFN, it can't be "lost".

Enough Wealth

Interest and Dividends are simple income items to calculate, with the only wrinkle being where a bank account is in joint names with DW I have to count half the interest earned on my tax return. This year I'll have earned more interest than usual, due to having a sizeable amount of 0% APR money invested from balance transfer offers. I usually don't leave too much cash sitting in interest bearing accounts as it is more tax effective to invest the money in high yield shares that pay fully franked dividends. With franking credits you have to declare the value of both the dividend received and the company tax paid, but you get a tax credit for the company tax that was paid. If your marginal income tax rate is less than the 30% company tax rate you will end up getting the surplus franking credit refunded.

For dividend income I keep all the dividend statements in one folder as they come in during the year, and also record the amounts into a spreadsheet. This makes it easy to spot if a dividend statement has gone missing, as there won't be the usual two dividends paid during the year. I've tended to less participation in dividend reinvestment schemes over the years - a combination of the extra paperwork required to keep track of the individual lots issued and the resultant complications in eventually calculating the capital gains when the stock is sold, and the phasing out of dividend reinvestment discounts by companies. Back in the 80s and 90s it wasn't unusual for DRPs to offer a discount of 5% or more of the average share price when issuing stocks under a DRP. These days most companies don't offer any price discount, so the only saving is the lack of any brokerage fee (but this is also not worth much now that online brokerage fees are so low). I still participate in a few DRPs where the number of shares issued is rounded up to a whole number. With small holdings the difference between getting 4.2 and 5 shares issued can significantly boost the dividend yield.

I also get all my dividends paid electronically into the one savings account, so it is easy to reconcile the dividend payments on my bank statement with my dividend spreadsheet. If any dividend statement has gone missing it will still appear on my bank statement, although I'll then have to do some research to check if the dividend was fully franked so I can compute the franked and unfranked components of the dividend payment and the corresponding franking credit.

If everything reconciles I can simply copy the spreadsheet totals of franked dividend, unfranked dividend, and franking credit into my eTax return. I also print a copy of the spreadsheet and store it and my dividend statements in the Tax Pack in case I eventually get a tax audit.

If I didn't manage my finances in a tax effective manner my salary income and my dividend income would combine to push me into the 42% tax bracket. As it is, using salary sacrifice and margin lending I end up with a total taxable income significantly less than my salary income alone would be. This means that my marginal tax rate is 30% (which applies to interest etc) and capital gains (held over 12 months) are taxed at only 15%.

Next - "Other" income in the Tax Pack Supplement

Enough Wealth

The Australian Financial Year end on 30th June, so it's time to start working on this year's tax return and to get organised for next financial year. My tax affairs are reasonably simple - I have some investments and a "business" that is run as a sole trader, so it just forms part of my personal tax return. I've always done my own taxes, so I've learned the relevant tax return requirements for my investments over the years as I started investing in each new asset class and investment vehicle. In this series of posts I'll go through the various parts of my tax return and how they relate to my investment strategy.

Even though I use eTax to submit my tax return, I still work through the "Tax Pack" as it helps get my documentation organised and I can scribble notations about any unusual aspects of the item calculations. I usually organise my paperwork and receipts in the same groups I used last year, and it's easy to work through the current Tax Pack using last years as a guide to what information goes in which section.

The tax return starts out with personal details. The information for this section is generally the same as last year, unless I've moved house. There's always a question about whether this will be my last tax return - I expect the answer to this will always be "no".

The first question in the income section is about salary income and PAYG tax paid. By the time you get around to filling this in it's way too late to do anything about this. I previously reduced this a bit by arranging for salary sacrifice of $450 a fortnight - whereby my employer reduced my salary by the requested amount and makes a corresponding increase in the amount of employer superannuation contribution paid into my retirement account. The means that this part of my salary won't be taxed at my marginal tax rate, but will be taxed at the 15% superannuation pre-tax contribution rate. When making these arrangements for the first time it's a good idea to double check that you're employer won't reduce the compulsory 9% SGL amount. For next FY I've requested the salary sacrifice increase to $1600 per fortnight. The only reason I can afford to do this is that I withdrew $34,000 of non-preserved, undeducted contributions from my superannuation fund.

Next post I'll go through interest and dividend income items.

Enough Wealth

An article in today's

SMH shows that the expected boom in superannuation contributions is occuring. Under the rules announced for the introduction of the "Simpler Superannuation" reforms to the Australian retirement savings tax laws, there is a one-off window of opportunuity to contribute up to $1m into your superannuation account before 30 June 2007. This is to "compensate" for the removal of age-based contribution limits with a flat limit of $50K pa of pre-tax (concessional, aka undeducted) contributions and $150K pa of after tax contributions. The new maximum contribution amounts will be indexed to increase in $5K jumps to keep pace with inflation.

This got me thinking about what the maximum amount that can be accumulated during your working life be under the new "Simpler Super" rules. Unlike the model of a minimum wage worker I posted a couple of days ago, this model has to make a few "bold" assumptions:

* the maximum contributions are made each year from age 18 to 65 ie. $50K pa pre-tax contribution via the SGL and salary sacrifice, and $150K pa of undeducted contributions. Although the $50K pre-tax and $150K undeducted contribution limits could easily be reached by a middle-aged, upper-management employee this is unrealistic for the under-30s worker. So this contribution rate would require some outside source of income. For example rich kids with an inheritance or a trust fund. I'm not fussed that very few people would possibly meet this requirement, we're just looking at what the extreme case could be under the new Superannuation rules.

* undeducted contributions aren't taxed on entry into a Superannuation account and pre-tax contributions are taxed at the concessional 15% rate

* the superannuation account is invested in a high-growth asset mix, achieving a real (inflation adjusted) net return (after fees and taxes) of 5% pa average for the 47 year investment period (up to age 65)

So, how much would this theoretical "rich kid" accumulate in their Superannuation account by age 65? Just over $37 million in today's dollars! And this amount can be withdrawn tax-free as a lump sum or a pension after age 60 (when "retired"). And this amount is per person, so a rich couple could accumulate a total of $74 million in this tax-sheltered environment.

As there is no gift tax in Australia, I imagine many rich households will be gifting $150K pa to each of their adult kids each year to put into their SMSF. The main downside of implementing such a strategy would be the legislative risk involved with locking this investment away until age 65. There could easily be further changes to the tax treatment of superannuation in the future.

Enough Wealth