6 Facts of Tax – Why your deductions are worth more and you pay less tax than you might think

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You probably pay less tax than you think and your deductions are worth more than you realise.

Read the 6 facts of tax and check out the tables below to understand:

  1. Why you pay less tax than you might think (and the difference between marginal and average tax)
  2. How much deductions can increase your tax refund
  3. How other (non-tax) items can reduce your tax refund

The article has been written on the basis of 2014 tax rates, however the principles remain the same and although the tax free threshold has changed in recent years (from $6,000 to $18,200) the net tax rates for those earning $30,000 or more have stayed similar since 2008.

 

  1. Why you pay less tax than you might think

Fact 1: Everyone gets low rates at the start

Marginal Tax – Everyone gets the first $18,200 free and the next $18,800 to $37,000 at 19%, whether you earn $1 million a year or $40,000.

In fact, you can earn up to $20,542 and won’t pay any tax (due to the low income tax offset which applies automatically when you lodge your tax return).

 

Fact 2: The tax you pay will often be much lower than your marginal rate

If you are in the 32.5% marginal tax bracket, it doesn’t mean that you pay 32.5% tax on everything (only amounts above $37,000).

In the tables below I show the Average tax percentage which is useful to consider how much tax you pay as a whole.

Average tax percentage is calculated by: Net tax paid

    Taxable income

Net tax paid is calculated as: Tax on income + Medicare Levy less any low income tax offset (LITO).

 

Low – Middle Earners

See the table below. With the 32.5% rate starting at $37,000 (which has an average tax percentage of 10%), the average percentage rises quickly to 18.3% average tax at $55,000.

Table for Low and Middle Income Earners – Tax Payable including Average Tax Percentage

Taxable Income

Tax on Income

Medicare Levy

LITO

Net Tax

Marginal Tax Rate

Average Tax %

A

B

C

D

E

 

F

=

     

B+C+D

 

E/A

18,201

-

-

-

-

19c

0.0%

20,542

445

-

(445)

-

19c

0.0%

24,000

1,102

346

(445)

1,003

19c

4.2%

30,000

2,242

450

(445)

2,247

19c

7.5%

37,001

3,572

555

(445)

3,682

32.5c

10.0%

45,000

6,172

675

(325)

6,522

32.5c

14.5%

55,000

9,422

825

(175)

10,072

32.5c

18.3%

65,000

12,672

975

(25)

13,622

32.5c

21.0%

 

High Earners

While you start paying 37c tax on every dollar earned above $80,000, you would need to earn $277,000 to pay an average rate of 37%.

The more you earn, the closer you will come to paying 45% tax plus 1.5% Medicare Levy.

Table for High Income Earners – Tax Payable including Average Tax Percentage

Taxable Income

Tax on Income

Medicare Levy

Net Tax

Marginal Tax Rate

Average Tax %

A

B

C

E

 

F

=

   

B+C+D

 

E/A

80,001

17,547

1,200

18,747

37c

23.4%

100,000

24,947

1,500

26,447

37c

26.4%

150,000

43,447

2,250

45,697

37c

30.5%

180,001

54,547

2,700

57,247

45c

31.8%

300,000

108,547

4,500

113,047

45c

37.7%

500,000

198,547

7,500

206,047

45c

41.2%

1,000,000

423,547

15,000

438,547

45c

43.9%

Although the average rate of tax is useful to know, I use the marginal tax rate to calculate the value of any extra income or deductions.

  1. Why your deductions are worth more than you think

Fact 4: Extra income and deductions = marginal tax rate

I consider that your taxable income is made up of two components:

  1. Salary (or business income) – tax free threshold
  2. Any other income (such as interest income) or deductions – marginal rate

I consider component 1 (your salary or business income) as being taxed first (and using the tax free threshold, 19% rate, etc.). I do this for a few reasons:

  1. Your salary/business income can’t be changed after year end
  2. Most people working one job have their employer withhold tax based on the tax free threshold

This means that component 2 (any other income or deductions) will affect your tax by your marginal tax rate (plus other items see fact 5).

 

Fact 5: Your marginal tax rate isn’t the only change to your tax refund

Additional income and deductions will be affected by more than your marginal tax rate. In addition to your marginal tax rate your tax will change by:

  • Medicare Levy – 1.5% for most people. Above $20,542 Medicare levy increases by 10% to reach 1.5% by $24,167.
  • Low Income Tax Offset – the offset reduces from $37,000 at 1.5% and cuts out completely at $66,666.

 

Example: 35.5% tax refund rate – Taxable Income between $37,000 and $66,666 - the tax reduction on deductions is: 35.5% being 32.5% marginal tax rate + 1.5% Medicare Levy + 1.5% Low Income Offset reduction.

Or put another way, each dollar of interest earned costs you 35.5c in tax and each dollar of deductions benefits you 35.5c.

 

  1. How other items affect your tax return

Fact 6: You might pay more than tax on your tax return

Your tax refund/payment may include some items which are not tax related. I note that the tables above don’t include non-tax items. Examples of non-tax items include HELP debt, Private Health Excess and Medicare Levy Surcharge.

HELP debt – You start repaying HELP at 4% ($51,308) and the maximum is 8% ($95,287) with 0.5% increments.

Example: Tony earns $62,500 HELP repayment income*. If he gives $100 as a tax deductible donation, In addition to the 35.5c mentioned above he also reduces his tax by 4.5c in HELP repayment totalling 40c (or $40 on $100 donation).

 

Private Health Excess* – The government has reduced the private health premium reduction (30% or higher for seniors) for high income earners ($88,000 for singles and $176,000 for families). So people who paid a reduced premium during the year have to repay the difference.

Medicare Levy Surcharge (MLS)* – If you earn over $88,000 single/$176,000 family and you/your spouse don’t have adequate private health insurance you are charged an extra levy. MLS was 1%, but can also be 1.5% or 2% depending on your income.

 

* Note that non-tax items like HELP and MLS usually don’t let you double dip (i.e. get a tax reduction AND a reduced HELP repayment). These items may calculate based on a figure higher than your taxable income (if you have reduced tax in certain ways for example reportable fringe benefits, reportable superannuation contributions and financial losses including rental losses).

Posted in Making Money, Tax

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