Careful tax planning may help an individual minimise their tax payable without resorting to evading tax responsibilities.

Tax planning versus tax evasion

The difference between tax planning and tax evasion is that the former makes use of and maximises legal concessions, exemptions, rebates, etc. to minimise tax liabilities while the latter uses illegal schemes to avoid paying tax.

For instance, a small business owner may use the $20,000 instant asset write-off—an ATO-approved scheme to help small and medium-sized enterprises (SMEs) minimise tax payable for the income year. However, if the purchased asset exceeds $20,000 but the business owner modifies its value to make it “qualify” for the instant asset write-off scheme and avoid paying tax, it’s considered tax evasion.

Types of tax planning

There are three types of tax planning that taxpayers should be acquainted with: permissive, short- and long-range and purposive tax planning.

Permissive tax planning
This refers to tax planning that uses strategies which fall within legislations. These involve using tax concessions, allowances and rebates, among others, to reduce an individual’s tax liability for the financial year.

This can be as simple as maxing out non-concessional superannuation contributions to claim a deduction for the contributed amount.

Short-range and long-range tax planning
Short-range tax planning is usually done at the end of the fiscal year to reduce an individual’s tax payable. For instance, an individual who donated $500 during the fiscal year may claim a tax deduction on the gifted money if it was given to ATO-approved organisations or deductible gift recipients (DGR).

Long-range tax planning refers to using tax strategies for specific purposes wherein the individual may not receive immediate benefits. For instance, by purchasing dividend-paying blue chip shares over other shares, individuals are allowed to receive recurring tax benefits in the form of franking credits.

Purposive tax planning
This refers to creating a tax plan that employs purpose-specific strategies to maximise the allowable deductions and other benefits that a taxpayer may access.

For instance, an individual may be advised to maximise their super contributions and contribute to their spouse’s super to claim the maximum tax deductions and offsets.

However, there are some tax evasion schemes marketed as purposive tax planning strategies. What these schemes do is to exploit or mislead existing laws to avoid paying the correct amount of taxes.

Taxpayers should make sure to understand the strategies to be used, especially if someone else is handling the planning and execution for them.

Tax planning strategies

There are many tax planning strategies that tax professionals and taxpayers can employ. Some of the common strategies used are:

Deferring income
Taxpayers and small businesses may choose to defer the receipt of their income until after the financial year closes so that the deferred income will be included in the next financial year.

For instance, an individual may consider choosing an investment that matures on July 1 instead of June 30 so that the yield on their investment will not be included as part of their assessable income for the current financial year.

Incorporating investment strategies
All income from investments form part of an individual’s assessable income. In this regard, some investors may select assets that are tax-effective or use gearing strategies to even out income and expenses or generate losses.

For instance, some property investors use negative gearing strategies to generate capital loss and use that loss against their tax payable for the current or succeeding income years.

Maximising superannuation
Concessional and non-concessional superannuation contributions and spouse contributions are deductible as long as they fall within the contributions cap. By placing extra income in super, individuals are allowed to remove the contributed amount from their assessable income.

For instance, an individual whose annual gross income is $100,000 may max out the $25,000 concessional contributions cap so that only $75,000 is counted towards their assessable income. Doing so also brings down their marginal tax rate from 37 per cent to 32.5 per cent.

Tax consolidation
Companies composed of several smaller entities may consolidate the group’s income for the financial year, and this allows them to use one entity’s tax benefits for the entire group.

For instance, a business owner operating three smaller companies gained a $35,000 profit from two companies but incurred $10,000 capital loss in the third. Consolidating the group’s taxes would allow the business to use the loss against the total profit so that the business only pays tax on the $25,000 portion of the profits.

Using trusts
Trusts are allowed to distribute income, profits and losses among its trustees. Using a trust structure would allow its trustees to soften the financial blow they may receive from taxes.

For instance, a trust operating a small business property that gained a $5,000 profit for the income year could be taxed at 46 per cent. By distributing this income among its five trustees, each $1,000 distributed is subject to the recipient trustee’s marginal tax rate instead—at a lower rate compared to the rate applicable if the income is left undistributed.

The importance of tax planning

Proper tax planning allows taxpayers to lower their tax payable without breaking the law while also allowing the government to avoid having to run after tax evaders. Tax planning benefits both taxpayers and the government because it serves as an acceptable and legal compromise when meeting tax obligations.

Individuals who think they may be eligible for deductions and other tax benefits but are not sure how to go about their taxes may consult tax professionals who can deliver appropriate advice.

This information has been sourced from the Australian Taxation Office.