10 costly tax mistakes
By Scott Francis
June 9, 2010
PORTFOLIO POINT: The clock is ticking to the end of the financial year. Here are 10 of the most common mistakes and how to avoid them.
In the end-of-financial-year rush to get their tax affairs in order many investors unwittingly make crucial mistakes that can add up to thousands of dollars.
The three weeks between now and June 30 might seem like plenty of time to make rational and informed decisions. But as illustrated by the one-time popularity of managed investment schemes – now shrunk to one tenth of the estimated $1 billion value achieved in 2008 – there is plenty of evidence to the contrary.
Olive groves and emu farms are just part of the story. It’s estimated that Australians only claim for about half their eligible charitable donations. We don’t pretend to know all the reasons why people donate, but we firmly believe their tax bill should be adjusted accordingly!
Knowing where your money has gone is a vital component of tax planning. But this time of year is also an excellent time to map out where your money is going.
Tax cuts, government tinkering around the edge of super and a sharp fall in share prices all demand careful attention and should be factored into your planning for the coming year … and the year after that.
We’ve also interviewed a number of top advisers about the biggest mistakes that investors can make. Their responses range from the technical to the practical and make for fascinating reading.
So in the spirit to which Eureka Report readers have become accustomed, here’s your guide to the biggest end of financial year mistakes made by investors and how to avoid them.
1: Making tax considerations drive your investment strategy
For the past few years I have dedicated part of my annual tax planning feature to warning investors about the risks facing various agricultural schemes. The collapse of high profile promoters Timbercorp and Great Southern should have eliminated any lingering doubts.
The schemes promised big upfront deductions and delivered planners fat commissions, but in reality they were serial underperformers and left many investors with greater tax liabilities later on. The investment case was unclear and the turmoil the industry now finds itself in serves as a powerful reminder of allowing tax concerns to drive your strategy.
Investors looking at tax-loss selling as a way of reducing capital gains should also tread carefully. Your portfolio may contain many candidates that will reduce your tax bill but consider your original investment thesis. Has the value of the assets or the outlook changed materially? Are you selling at the bottom of the market?
2: Parking money in managed funds
One of the big criticisms of managed funds is that they are tax-ineffective and those who invest in June will suffer the most. Most funds pay their biggest distributions on June 30. Distributions are the same regardless of how long the investor has held the units. The problem for investors is that these distributions are taxable.
For example, a person who invests in a fund in late June might pay $1.50 per unit for an investment in a managed fund. If that fund distributes a fully franked dividend of 4 cents per unit, with 6 cents of capital gains, the fund price will fall to $1.40. For the investor who only invested in late June their investment is now valued at $1.40, and they have to pay tax on 6 cents per unit of capital gains, even though these gains occurred before they invested in the fund. If you must invest in a fund, wait until July.
|TIP: Doug Turek of Professional Wealth, says it’s a mistake to make the same claims for structured products as you did in previous years; they don’t enjoy the same tax breaks since Wayne Swan made changes in the 2008 federal budget. “Don’t make the mistake of thinking that you can deduct the full cost of the capital protection component, because you can only claim the interest,” Turek says.
3: Attempting a “wash sale”
Many investors will have portfolios that show capital losses. One strategy that investors have used in the past is to sell shares in the last day of the financial year only to repurchase shares the next day. This allows investors to crystallise the losses and offset them against any capital gains while retaining ownership of the shares.
The tax office has warned it will take a dim view of those who participate in such a strategy. If you are seeking to minimise your tax position by selling underperforming shares in the leadup to June 30, by all means do so but if you plan to buy them back again know that the definition of what constitutes a “wash sale” is fluid. You have been warned.
4: Deductions that don’t match your personal situation
The accepted logic when it comes to deductions is to bring forward as many as you can. For example, if you have a work-related expense that you will incur over the next month, it is often better to make the payment now so that you will receive the benefit in this year’s tax return.
The exception to this is if you expect to earn substantially more next year. If, for example, you have earned very little income this year it is likely to be to your advantage to delay any tax-deductible payments until next financial year, when you are earning income at a higher tax rate and therefore the financial benefit of the tax deduction will be greater. In other words, the decision to bring forward a deduction was a mistake.
You could also make a mistake if you defer expenses when you anticipate earning less next financial year through a redundancy or through maternity leave. In this case it is a better idea to bring the payments forward.
|TIP: Alan Dixon of Dixon Advisory, says it’s a mistake to assume that your accountant won’t be busy approaching end of the financial year. “Coordinate with your accountant, financial planner and broker earlier so that it you’re not in a mad rush to get your tax return ready on time,” he says. “Some clients turn up on June 30 and want us to lodge their return; it’s just not possible.”
5: Putting too much in super
Current super rules allow investors aged up to 50 to contribute up to $25,000 a year while the over 50s can contribute up to $50,000 a year while making the most of the concessional contributions tax of 15%. Sums of money over these limits will be subject to your top marginal rate, which could be as much as 46.5%.
But even non-concessional contributions are capped at $150,000 and sums of money directed into your super above and beyond this limit can be levied at a whopping 93%. Be mindful of just how much you have directed into super during 2009-10 and if you aren’t sure, then check!
Remember that from July 1, 2012, over-50s will only be able to make contributions of $50,000 a year if their balances are less than $500,000 so make the most of it while you can.
6: Putting too little in super
If you or your spouse is earning less than $60,000 a year then it is also worth considering whether you can make an additional after tax deduction to superannuation and collect a government co-contribution.
The best way to go about this is to work out the best estimate of your annual income, and contact your superannuation fund about how you can make the contribution, and how much you should make. If the relevant party earned less than $31,920 in 2009-10 and you make contribute an additional $1000 you can collect an additional $1000 courtesy of Canberra.
The tax office has made more information about the government co-contribution available here, but keep in mind that contributions have to be received by funds prior to June 30; don’t leave it too late!
|TIP: Roger Timms of Taxpayers Australia says many investors misinterpret the 45-day rule for franking credits. Timms says many investors are unaware they must hold their shares for at least 45 days, not counting the days of purchase or sale (assuming their franking credits are in excess of $5000. If they are not held for 45 days, you lose the benefit of the franking credits.)
7: Squandering tax cuts
Almost all income earners will receive a tax cut ranging from $300 to $1300 over the next financial year. Instead of breaking out the Grange, why don’t you bolster your financial position and earmark those extra dollars for extra mortgage payments or additional super contributions?
While a few dollars a week is unlikely to make an immediate difference to your lifestyle, over time it will have a much bigger impact. It also helps build a financial habit that will lead to greater financial success over time: capturing surplus income to build wealth rather than letting it slip through your fingers.
8: Failing to claim for charitable donations
Some estimates put the value of eligible tax donations claimed by taxpayers as only about half of funds donated. That means that there is a ton of money being donated and not being claimed. One answer might be to take a more businesslike approach to these donations: carefully choosing an organisation or organisations and making the donation at a time that suits you, with June the time likely to be make the most sense for people as they plan for the end of the financial year.
|TIP: Noel Whittaker, director of Whittaker Macnaught, says investors are often confused about the administration of capital gains tax (CGT) when involved in DIY share trading and property. In determining when a CGT event has occurred, it’s important to realise that it is the contract date of the sale or purchase, not the settlement date, that dictates the when the transaction occurred.
9: Not claiming the $1000 tax exemption for employee share programs
Investors that are able to salary-sacrifice into employee share programs are able to claim an exemption on the first $1000 of the discount offered tax-free. Not everyone will have a scheme like this at their disposal but many Eureka Report subscribers working in listed companies will, and they need to be aware of this concession.
How it works is that if you salary sacrifice $20,000 worth of shares offered to you at a 20% discount then you are able to claim the first $1000 of your $4000 discount as tax-free, before paying the remaining $3000 at the marginal rate.
As I said, this won’t apply to everyone but this is potentially a big-ticket item! Don’t hesitate to ask your accountant for more details if you are unsure.
10: Failing to get organised
How much time are you spending on organising your tax return? Would you prefer to be doing something else?
The bottom line is that tax time is a measure of how organised you are. Where are the invoices for work-related expenses? Where are the receipts for charitable donations? Where are your dividend and interest statements? The best way to get on top of this paperwork is to pledge an oath to being organised at the start of the financial year so next year you can concentrate on making money … or playing golf.
Scott Francis' articles in the Eureka Report