How much is my tax deduction worth?

Understanding the value of your deductible expenditure and the benefit of that spending on your disposable income is crucial.

In general, we tend to think spending a dollar on tax deductible expenses or assets, it will save us a dollar in tax.

Sadly, the tax man is not that generous. In fact, with the ongoing changes to marginal tax rates, there is less advantage given to lower income earners.

To illustrate, let’s consider you, as an individual taxpayer and the marginal tax rates that apply to you for the 2014 tax year:

0 $18,200 $NIL
$18,200 – $37,000 $NIL plus 19 cents for each dollar over $18,201
$37,001 – $80,000 $3,572 plus 23.5 cents for each dollar over $37,000
$80,000 – $180,000 $17,547 plus 37 cents for each dollar over $80,000
$180,000 and over $54,547 plus 45 cents for each dollar over $180,000

READ: BUDGET2016 | The government’s personal income tax cuts explained

If your taxable income is less than $18,200 per year, you will not pay any tax. Technically, if you buy that tax deductible subscription, you will not receive a tax saving because hey, you’re not paying tax anyway.

But let’s imagine you earn more than $180,000 and you spend a dollar on the same tax deductible subscription. How much tax will you save and get back from the tax man?

Any income earned over $180,000 attracts tax at 46.5 cents in the dollar (including the Medicare levy of 1.5 percent), so a $1 tax deduction will give you a tax saving of 46.5 cents.

But what is the actual cost of the subscription once tax is accounted for?

The $1 for the subscription less a 46.5 cents tax saving equals an out of pocket cost of 53.5 cents. Not bad!  It’s no wonder those who have taxable incomes over $180,000 say, “I love being in partnership with the tax man!”

Why do you think people who earn over $180,000 do negative gearing with residential property? It’s because every dollar they lose, the tax man pays nearly half of that loss in tax savings.

For the uninitiated, negative gearing involves investing in property or shares and so on, where the expenses of ownership such as, interest paid, rates, insurance, agent’s commission etc. exceed the rental/dividend income, with the resulting loss being claimed against your other income.

But, even though the tax man is paying for nearly half the loss, the investment in the property or shares is only worthwhile if the property or shares go up in value and recover the after tax costs of the years of ownership plus some.

Remember, tax is a consideration when negative gearing into assets, but it’s not the only consideration.

So where does that leave you if your taxable income is less than $180,000? Well, it will depend on what your taxable income is.

If your taxable income is between $37,001 and $80,000, every dollar you spend on tax deductible costs will earn you a tax saving of 25 cents including the Medicare levy.

Should you rush out and start spending?

Well, the higher your taxable income the more the ATO will shelter the cost, but I would suggest that at lower taxable incomes, incur the cost only if you really need to.

Your tax paying entity/company will also have an impact on your tax saving.

For example, a company is taxed at 30 cents in the dollar and a self managed superannuation fund (SMSF) is generally taxed at 15 cents in the dollar assuming it is in accumulation phase. So a dollar spent on a tax deductible expense in a company or SMSF will cost the company 70 cents after tax and the SMSF a significant 85 cents after tax.

This begs the question why negative gearing into property in an SMSF is considered so attractive when you consider that every dollar lost after rental income, the tax man only pays 15 cents.

The SMSF funds every dollar lost to the tune of 85 cents.  All I can say is that the investment had better be a good one, if it is to recover the after tax losses over the period of ownership and still provide the SMSF with a solid capital gain.

Don’t forget there are other tax concessions available that will impact your decision on whether you incur a cost or not.

Obtaining a tax deduction in June 2013 will mean that you will receive the tax credit for that cost in your 2013 income tax return, and accordingly you will receive the refund for the expense when you lodge your 2013 tax return.

Incurring the cost in July 2013 will mean that you will not receive the tax saving until you lodge your 2014 income tax return and that is at least another 11 months.

In essence, timing is a consideration, but only if you really need that tax deduction.

For other compelling ways to save tax, read Ryan Miller’s blog, “Want to reduce tax? The tax write-off way”.

Always think about the need, the timing and the tax saving (based on the applicable marginal tax rate) when offloading those hard earned dollars of yours.

Small business owners need to meet all their tax and compliance obligations.

Visit MYOB’s Tax Changes Information section, specifically prepared to assist startups and small businesses to stay on top of their game with tax changes.

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The information provided here is of a general nature for Australia and should not be your only source of information. Please consult an experienced and registered tax agent as each small business’ circumstance will vary for end of financial year.