Count the costs before deciding to prepay for a tax deduction

Bringing forward tax deductions sounds nice but it must also make financial sense

PREPAYING expenses in June is a popular strategy for individuals, investors and business owners seeking a quick tax deduction, but is it really worth it?

The idea of paying for something this month and then getting a chunk of it back from the taxman next month sounds nice, although it’s wise to crunch the numbers before parting with your money early.

The most popular prepayment is interest on investment loans for property or shares, while individuals often prepay work-related expenses and business owners prepay a pile of stuff.

It can be a good idea if you are looking to offset one-off capital gains or if you get a discount by paying in advance.

If you are offered a lower interest rate for a making a prepayment, check that it’s a good deal, particularly in today’s environment of falling interest rates. If rates drop further you may end up paying more in interest if you prepay, while your money may work harder for you by paying down a credit card debt now or sitting in a mortgage offset account.

Prepaying expenses before the end of the financial year can be a good idea if you are looking to offset one-off capital gains or if you get a discount by paying in advance.

H & R Block’s director of tax communications, Mark Chapman, says individuals can prepay annual subscriptions to work-related journals in June then get the tax deduction for it in July.

“People often prepay income protection insurance to get the tax deduction,” he says.

Remember that if you prepay an expense such as loan interest this year, you’ll have to do the same next year to keep the tax benefit flowing. Otherwise there will be a future financial year where you get no deduction for it.

“The initial benefit comes the first time you do it,” Chapman says.

“Do your sums — don’t do it just to get a tax saving if it’s going to cost you more in the long run.”

Peter Bembrick, a tax partner at HLB Mann Judd in Sydney, says prepayment strategies often work best when your annual taxable income is near the key tax bracket thresholds of $37,000, $80,000 and $180,000.

“If there’s a one-off gain that will push your income up and over a tax threshold, it might be worth having extra deductions this year,” he says.

“If you are going to prepay to get a discount or good deal, that’s a financial reason to do it. Question is it actually a good deal. From a tax point of view, there are pros and cons depending on your situation.

“You are bringing forward a tax deduction so that can be beneficial. Think about whether your income is likely to change.” If prepaying won’t move you into a lower tax bracket “you are not really saving tax by moving deductions around,” Bembrick says.