Steps to reduce your tax ahead of the stage-three cuts

Treasurer Jim Chalmers has committed the government to implementing the stage-three tax cuts. Picture: Martin Ollman

In what seems like a long time ago since they were initially announced, the stage three tax cuts proposed in the 2018 federal budget from the former Turnbull/Morrison government are finally due to come into effect from July 1 next year.

Despite the estimated cost of $313bn over the next 10 years and the worsening position of government finances as predicted in Treasury’s recent 40-year outlook in their Intergenerational Report, Jim Chalmers has been firm in his dismissal of any suggestion that Labor would alter these already legislated tax cuts.

With that in mind, taxpayers should think about how they might be able to optimise their taxes given the somewhat unique position we are presented with – significant changes will occur to personal income tax brackets from next financial year.

The objective of the tax planning exercise should be relatively simple – bring forward tax deductions to this financial year when the tax rates are higher, defer income and gains until the next ­financial year when the tax rates drop and become more favourable and finally, review any existing structures such as investment bonds that limit tax to 30 per cent that may become obsolete from next financial year.

Juston Jirwander, director and chartered accountant at Bishop Collins, says: “Stage one and two tax cuts focused on low to medium income earners. However, stage three tax cuts favour those on six-figure incomes. Someone earning $200,000 this financial year will pay $60,667 in tax, whereas this decreases by $9075 to $51,592 next financial year after both the 32.5 per cent and 37 per cent tax brackets are removed and replaced with a new flat 30 per cent tax bracket from $45,000 to $200,000.”

In terms of how to reduce your taxable income this financial year, there are a few options. The one that seems to make the most sense is to prepay interest on investment loans before June 30, 2024. In normal times, prepaying interest is purely a tax deferral strategy, but in this financial year it may also ­result in a tax break.

In other words, the tax saved by prepaying interest is likely to be larger this financial year compared with next financial year due to the changes in tax brackets. A few other tax-deductible expenses that you could also consider prepaying this financial year include income protection insurance premiums, investment property insurance and interest on geared share portfolios.

If your super balance is less than $500,000, you may also have the catch-up concessional contribution amount available to use ­another tool in reducing taxable income this financial year. By going back up to five financial years and using your unused pre-tax super cap, there is an opportunity to make a larger super contribution this financial year and reduce your taxable income. Either ask your accountant or find out yourself by logging onto the ATO portal of myGov and checking your available catch-up concessional balance. But if your tax­able income is $250,000 or more, Division 293 tax will apply and reduce the attractiveness of making extra super contributions as you will be taxed at 30 per cent instead of the normal 15 per cent rate on the catch-up contributions.

And on the other side of the ledger, when thinking about capital gains and other taxable events, the deferral strategy until the 2024-25 financial year may result in a better outcome from a pure tax perspective for people with taxable incomes of less than $200,000. Deferring the sale of business assets, shares and investment properties all seem like the obvious choices. However, there are other assets that should be considered such as family trusts and adjusting the distribution rate to beneficiaries.

At present, trustees of family trusts who aim to optimise the tax outcomes of beneficiaries will try to limit trust distributions to $120,000 per year beneficiary taxable income. This is where the current marginal tax rate changes from 32.5 per cent to 37 per cent plus Medicare levy. However, from July 1, 2024, trustees will have the opportunity to increase trust distributions to up to $200,000 taxable income and the beneficiary will only have a marginal tax rate of 30 per cent.

Similarly, business owners who are holding retained earnings are counting down the days until July 1, 2024 so they can start to pay themselves a higher level of dividends in order to more tax-effectively access business profits.

While the stage three tax cuts seem to produce a lot of winners, there is one big loser – investment bond providers. Investment bond products are promoted on the basis that they provide tax breaks to most people by limiting tax on earnings and capital gains to 30 per cent within the bond structure due to the special legislation that governs investment bonds. This has been great for individuals with taxable incomes above $45,000 where the tax bracket changes from 19 per cent to 32.5 per cent tax plus Medicare levy.

However, from next financial year, people can earn up to $200,000 and only pay 30 per cent marginal tax. And as such, we are likely to see a drop in the uptake of investment bond products. Seventy per cent of tax payers earn more than $45,000, but less than 4 per cent of taxpayers earn more than $200,000. So in most situations, the use case for an investment bond may be weakened from July 1, 2024 and there could be outflows from investment bond providers as people cash out and opt for simpler investment arrangements in their personal names.

Given we are still less than half way through the current financial year, there is plenty of time to think about your three-part tax minimisation strategy; reduce taxable income this financial year, defer income and gains until next financial year and reassess the ongoing need for tax structures such as investment bonds if all family members earn less than $200,000.

James Gerrard is principal and director of Sydney planning firm www.financialadvisor.com.au