How to Reduce Taxable Income in Australia?

I get it, even thinking about doing your tax return is intimidating for many. But if you know you’ve done the most you can to minimise how much tax you pay, and instead maximise how much of your hard-earned income stays in your own pocket, then at least you can feel a sense of achievement and satisfaction.

Nothing is certain except death and taxes. In other words, paying tax is inevitable. But there are methods to (legally!) reduce your taxable income and save some money during tax time. I’ve outlined seven ways below, let’s get started.

1- Take advantage of salary sacrificing

Salary sacrificing, also known as “salary packaging”, offers a way for employees to reduce the amount of tax they must pay, and it works in a few different ways. To benefit, you forgo part of your pre-tax pay before you receive it. For example, it can be used to pay for a new car, insurance, computer, mortgage or rent payments and more. Salary sacrificing is available for anyone who earns more than the $18,200 tax-free threshold, however it is most suitable for individuals on mid to high incomes.

These benefits, known as fringe benefits, can save you thousands a year in tax. However, there are limits on what can be salary sacrificed or salary packaged, as potential Fringe Benefits Tax (FBT) can impact on the type of items your workplace is prepared to offer. Most employers will offer salary sacrifice to super but it is best to talk to your employer to see what other benefits they offer. This is because the Australian Taxation Office (ATO) imposes a FBT on employers, which forces them to offer limited fringe benefits to employees.

Nevertheless, if you opt for fringe benefits by sacrificing a portion of your salary, you can reduce your taxable income because these expenses are deducted from your pre-tax salary.

2- Contribute to your super

If you’re employed, your employer should be paying a percentage of your earnings into your super account. However, making extra contributions to your super fund by salary-sacrificing a portion of your pre-tax pay cheque is another great way of paying less tax.

The extra payments, called concessional contributions, are taxed at 15%. For most people, this will be lower than their marginal tax rate (which can be as high as 49%). You benefit because you pay less tax while you boost your retirement savings.

Just be aware the ATO has imposed a limit on the salary-sacrificing amount you can contribute to your super fund each year. From July 01, 2021, the concessional contributions to super funds for all individuals are capped at $27,500 irrespective of age. In other words, your employer and salary sacrificed contributions must not be more than $27,500 per financial year. Above that and your contributions will be taxed at your marginal rate.

3- Use a mortgage offset account

If you have taken out a home loan, you can use your mortgage offset account to minimise your taxes. For those who don’t know, an offset account works like a transactional or savings account that is linked to your home loan. The balance in your offset account offsets the balance of your mortgage loan, which reduces the interest payments and the loan term on your home loan. For example, if your home loan amounts to $500,000 while you have $50,000 in your offset account, you will pay interest on $450,000 ($500,000 – $50,000). You get the tax benefit as the interest you save using your offset account is not taxable.

4- Get private health insurance

While getting private health insurance is a personal choice, those who don’t have it may have to face tax implications. For example, higher-income earners who don’t have private hospital cover have to pay Medicare Levy Surcharge (MLS) as a tax penalty. The surcharge is in addition to the 2% Medical Levy that is imposed on all taxpayers irrespective of their total taxable income.

The Medicare Levy Surcharge is charged if a single person makes more than $90,000, or a family earns more than $180,000 in a year. The threshold for MLS is increased by $15,000 per child for families having two or more dependent children. So, if you want to avoid the MLS penalty, you can consider purchasing private hospital cover, which can save you some tax, depending on your earnings level.

Get private health insurance

5- Claim different types of tax deductions

You can claim tax deductions for eligible expenses that you incur to generate income. To claim tax deductions, you need to keep the receipts of the expenses. Tax deductions will lower your taxable income on which your income tax liability is calculated, which means that tax-deductible expenses can reduce your tax bill. You can claim tax deductions on the following types of expenses:

  • Work-related expenses: Work-related expenses that you can claim depends on the type of job you are doing. For example, if you work as a tradesman, you can claim the cost of tools. If you work from home, you can claim expenses related to working from home, such as your telephone and internet bill.
  • Travel & Vehicle expenses: Those expenses that are directly related to your work are allowed as taxable deductions. However, travelling expenses to and from work are not allowed as taxable deductions.

Other types of expenses that are tax deductable include:

  • Donations: Donations of $2 or more to registered charities are tax-deductible.
  • Tax filing costs: Expenses related to managing your taxes, such as paying your tax advisor for filing tax returns for you, are allowed for taxable deductions.

To claim those expenses as taxable deductions, you must have receipts of expenses and the payments must be made by you from your own pocket and not reimbursed to you.

6- Use offsets to your advantage

Tax offsets are rebates given to a certain group of people to make paying taxes affordable for them. Tax rebates or offsets are deducted from your tax liability, which reduces your tax bill. You need to check with the ATO if you are eligible for tax offsets. Usually, tax offsets are offered to low-income earners, individuals with dependent relatives, people who are on government benefits, people with private insurance plans, pensioners, and older citizens.

7- Save taxes on capital gains

Capital Gains Tax (CGT) applies when you sell an asset and realize a profit. However, the rate of tax applied on the sale amount depends on how long you have owned the asset before selling it. For example, if you sell the asset after owning it for less than 12 months, you will be charged a 50% additional capital gains tax on top of your marginal tax rate. Conversely, if you sell it after holding it for more than 12 months, you will only be charged the marginal tax rate on the amount of sale.

In contrast, if you make a capital loss on a sale, you can carry forward the loss in the future years. The carried forward losses can offset potential gains in the future years, giving you a tax advantage.

Get private health insurances

Conclusion

Paying taxes can be a painful experience but fudging the numbers and breaking the rules can make it more painful for you later. The ATO will investigate tax deduction claims that look suspicious but there are plenty of ways that legally allow you to reduce your taxable income. In this article, we discussed some of the options by which you can lower your tax bill. However, each individual has unique financial circumstances, and some of the tax-saving strategies we discussed might not apply to you. We recommend talking to a financial advisor or browsing the ATO website for information on any of these options that are relevant to you.

B M Peachey

B M Peachey, has over 15 years of experience investing in property and the stock market, in both New Zealand and Australia. She has a post-graduate degree, with qualifications in Finance and Mortgage Broking and in Accounting and Bookkeeping. She is passionate about ensuring people have access to credible, reliable, and easy to understand information to help them get in control of the life they REALLY want to live.

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    Disclaimer: The information in this article is general in nature as it has been prepared without taking account of your specific objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstance before acting on it, and where appropriate, seek professional advice from a finance professional such as an adviser.