The Tax Deduction Lie

I thought I would write a blog on something that has come up a lot recently….. chasing tax deductions!

Myth 1 – If you claim $100 in deductions, that increases your tax refund by $100?

This is completely false. You only get a proportion of the amount spent back – at best $47 of every $100 you spend ( and that assumes you earn over $180,000). Importantly, that means if the expense wasn’t on something you were going to spend it on anyway, or to help boost future income, or build an asset, you have wasted the other $53. For most taxpayers, your average tax rate might be 22% to 35%… so it is even worse.

Remember, cashflow is king for businesses – why waste money? The cheapest and best option for cashflow is to pay the tax and bank the surplus. This is because the reverse is also true, you pay tax on the $100 of $47 (worst case) and get to keep the $53. Who doesn’t want more money in their bank account?

Instead, your tax deduction goal should be ensuring that all expenditure is claimed where possible to the maximum amount allowed. For example, a car. We might incur that cost anyway whether in business or not, so how do we maximise the claim?

Myth 2 – Deductions are good?

As pointed out above, deductions are only good if they are for necessary business expenses, to help boost your future income or build an asset. Importantly, in the “old days” you could add some of these extra deductions back when you went for bank loans or were selling your business.

Now days, the banks and business buyers take almost purely the numbers on your tax return. We have seen many people save a bit of tax now, only to miss out on the home, or commercial premises, of their dreams because the bank have knocked them back.

Don’t cut off your nose to spite your face.

Myth 3 – Deferring tax is good?

This is a “depends on your personal circumstances” type question. Instead of focusing on deferring tax, focus on why you got into business and let that drive your decisions.

For most, that will include building wealth, reducing debt, more freedom, retire early so-on. In many cases, that means paying a bit more tax upfront, so you can make more money, reduce your home loans, build your assets and be better off overall. Also, for some, knowing they have deferred tax only causes more stress… wondering if and how they will pay it in future.

The same logic applies to buying assets under the “$20,000 immediate write off” deduction too. Importantly, this isn’t an extra tax deduction at all, the deduction always existed. They have just brought it forward (upfront vs depreciation over a number of years). So this is a deferring tax strategy, rather than a saving tax strategy.

Accordingly, the decision to buy a new business asset or to defer tax should fit in with your overall business plans and life goals, rather than thinking about the tax you need to save.

Myth 4 – Once you go over a tax bracket you pay a higher tax rate on all your income?

I hear this one all the time. “I don’t want to be paid over $45,000, as my tax rate will go up!” True, it goes up… but only on the income over that bracket, not all the income.

If you earn $1million dollars, you still pay nothing on the first $18,200, then 19% on the income between $18,200 to $45,000 (2024 rates) and 32.5% on the income between $45,000 and $120,0000 and so-on.

A good way of looking at this situation is…. Do you think the CEO’s of banks and big companies go into their job interviews asking to cap their salary at $45,000 as that is where a tax bracket ends? Never…. they get paid millions. Why…. Because they want more money, regardless of the tax.

You should be looking at your wage and business profits in the same way. You should be paid the amount you need to fund your lifestyle (what makes you happy) and what you are worth, not necessarily where a tax bracket cuts out.

Myth 5 – Structures like companies save tax?

This is at least partly true for some businesses. However, most structures only delay tax, not save tax.

For example, we will look at a company. It pays tax at 25% for the 2024 tax year. This sounds fantastic if you are a high income earner and currently being taxed at 37% or higher. However, what many accountants don’t tell you, is that when the money comes out of the business, you then pay the top up tax between the company tax rate and your personal tax rate.

So, if your goal is to use the funds personally…. And who doesn’t want to use the money you have worked hard for (holidays, reduce home loans, buy investments, pay for private school fees so-on), then you need to pay individual tax rates. The company structure can help defer it for a few years, but not permanently.

Companies/Trusts are actually used to provide other benefits like asset protection, flexibility, suitability for business partners, defer tax to fund agressive expansion and so-on. Good planning with an accountant can also use structures to maximise tax effectiveness.

So do Holmans get the best deductions for our clients…… you bet we do! We go through our client’s stuff in detail, trying to find out what we can claim. The key here is looking for deductions where the client has already decided it was a good decision to spend the money. We are not trying to convince clients to spend money just so they can get a tax deduction.

Do I believe in tax minimisation planning – Absolutely! Again, it is about looking for sensible opportunities and only where the client will benefit overall (i.e. super contributions, investment property so-on). A big part of tax minimisation planning is helping our clients reach their goals, not just one-off strategies, but long term tax effective structuring and planning.

My overall recommendation – Chase higher profits and more tax… not tax deductions. You will have more money to spend, you will have a better lifestyle (more options anyway), better borrowing capacity and less stress over cashflow. What doesn’t sound good about that!

Hope this article was helpful.

Disclaimer: This article contains general information only. Regrettably, no responsibility can be accepted for errors, omissions or possible misleading statements or for any action taken as a result of any material in this guide. It is not designed to be a substitute for professional advice, as such a brief guide cannot hope to cover all circumstances and conditions applying to the law as it relates to these items.

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