“We are taxed twice as much by our idleness, three times as much by our pride, and four times as much by our folly.” Benjamin Franklin
I use Benjamin Franklin’s quotes often for my articles. This time I will not comment on the tax on our idleness or the tax on our pride although I know it is high. This article will focus on the last part of being taxed “.. four times as much by our folly”.
We are often asked by new clients to assist them reduce tax after a tax event has been completed. These include situations where there has been a sale of a property, and the client is wanting to know how to reduce tax liability on their gain. This is one such example of a Folly and can result in paying more tax than is intended or more tax than is fair.
Arming yourself with knowledge, or asking people who have that knowledge, can drastically reduce tax and help high net worth individuals to ensure they do not pay more than they need to.
My goal is to share some knowledge that will help you to reduce your ‘Folly Tax’.
The best way to provide advice that sticks is to share real life examples. I have summarised these stories into 4 main categories:
- Timing is King
- Structure, Structure, Structure
- Knowing the opportunities
- Discipline is essential
Timing is King
Deciding on the timing of your purchase and sale of an asset is critical and can save you thousands.
Story 1 – Adapted to protect client identity.
John holds a number of listed and private securities as well as two properties in his own name, plus a business run through a company with his Family trust as shareholder. He is married with adult children. In addition, he has a Bucket company or Investment company that holds the profit from the company in a secure environment. Risky assets are separated from non-risky assets so his business asset protection structure is sound and works well.
John had planned to sell some property to adjust his investment portfolio and sold the property that he held in his own name. He exchanged contracts on 15 June and settled on 31 July of the same year. It resulted in a capital gain of Circa $600,000 after concessions were applied.
He was aware of the potential tax on the gain, but he had unrealised capital losses on some shares he knew would be of little value as the company was close to insolvency. He chose to hold out, and in January of the following year, the company went into liquidation and the shares were written off. This resulted in a Capital Loss of Circa $500,000. John was of the understanding he could offset the loss against the gain from his property and did not speak to his advisors as he normally would. This was John’s biggest mistake in regard to his business asset protection and tax reduction strategies.
He was shocked to find that he was taxed at 47% on the total $600,000 gain on the sale of his property. This was because the deemed date of sale for tax purposes was the date of contract exchange of 15 June, meaning the share write off was the following tax year.
He had to pay $282,000 of tax on the Gain on sale of the property compared to $47,000 if he had realised his shares loss and sold them before 30 June. According to my calculations that’s 6 times the tax for this folly. A note that not all is lost – John is still able to carry forward the tax loss on his shares and may be able to offset against future capital gains. So maybe 4 times as much tax is accurate.
Always speak to your tax accountant before you plan to Buy or Sell an asset.
Structure, Structure, Structure.
The ownership structure of businesses, assets, and liabilities is very important in asset protection, tax reduction, and strategic planning. In particular these business asset protection and wealth management strategies are important when planning the sale of a business or succession plan for a business.
Story 2 – Adapted to protect client identity.
Beth, a new client, was running a successful business as a sole trader over the last 2 years, earning $400,000 in taxable income and paying considerable tax. She did not want to have a company when she started as it seemed too difficult, cost too much for a startup 15 years ago, and she was not sure if she would be successful. Beth was employing 3 people and held many clients. In her business, she held assets in her own name being office equipment, specialist computers, and vehicles. All in all, Beth’s business grew faster than she had expected.
Beth wanted to reduce her tax liability, have the ability to bring on partners and investors, and transition to retirement by working less hours immediately to eventually fully retire in 5 years time. Her structure did not allow for this transition and did not allow for her to reduce her tax burden or separate risky assets such as a business from non risky assets.
Beth sold her business being the goodwill, names, contracts, staff , knowledge , database, systems, and intellectual property into a company, and moved her shares into her own Discretionary Trust.
Beth had no children, however her niece had been working in the company and wanted to take over the company. Leading up to Beth’s 5 year retirement plan, her niece would learn the ropes to eventually take over.
The business was valued by an external party at $950,000. Beth was able to claim the small business 15 year CGT exemption and paid no tax on the sale to the company. Beth provided Vendor Finance to her new company which repays her $950,000 loan with interest.
The company continued to make a profit of $400,000 each year and the niece slowly acquired shares in the new company so that after 5 years she would own 80% of the company.
Beth in the meantime, paid no tax on the sale of the business to her new company, and has $950,000 she can draw on tax free from the company as it continues to earn money. The new structure has reduced the yearly tax from the business profit from Circa $188,000 to $100,000.
The new structure also means Beth has a succession plan in place and can retire with a minority interest still earning her income and involvement in the business as and when her niece needs it. It’s a win on many fronts just by getting the right structure.
Getting the right structure before you start a business or purchase assets is ideal. However, there are also concessions which allow for the creation of a better structure. It is never too late to get that perfect structure and sometimes the perfect structure will change as the family group changes.
Knowing the Opportunities
By learning what can work for your unique situation you will be able to take up opportunities or take actions that can reduce risk, reduce tax, and maximise your wealth ensuring your wealth management and assets are protected.
Story 3 – Adapted to protect clients identity
Peter and Mary are both independent clients that have similar situations personally. They both have adult children they wished to support in purchasing a property. Mary was a client of many years and Peter only recently a client, who did not interact with his previous advisor much.
Peter and Mary used their Family Trust to distribute and loan funds to their children to help them purchase a property sooner. Mary’s adult child, on purchasing the unit, lived in it for three months before moving back home to live with parents while renting out the property to tenants. Peter’s adult child chose to get a tenant in straight away and rent out the property.
Both rented the property for circa 5 years before wanting to sell their unit and upgrade. They both sold their respective properties, and, for the sake of the example, both made a capital gain of $200,000.
The main residence in Australia is generally not subject to capital gains tax. Usually, a property stops being your main residence when you stop living in it. However for Capital Gains Tax purposes, you can continue treating a property as your ‘main residence’ for up to 6 years if you used it to produce income. This is known as the 6 year rule.
The problem for Peter’s adult child is that when they bought the property it was never lived in by the adult child, and so never became an eligible main residence for that child. Mary’s adult child however did live in the unit for 3 months and then decided to rent it out and live back with parents as it was cheaper to do so. The net effect is that Mary’s child paid no tax and Peter’s child paid tax on the taxable Capital Gain of $100,000 at their marginal rate. Between the children, the difference in tax was more than 4 times.
Before buying a major asset , educate yourself and/or seek advice from professionals that can save you significant tax.
Discipline is Essential
Mixing ‘timing is king’ with ‘knowing the opportunities’, there is still the discipline to seek advice and act when it is required.
Story 4 – Adapted to protect client identity
Henry sold a property and made a large Capital Gain. He chose a year where other income was lower than normal after speaking to us in his tax planning session. However, the Assessable Capital Gain after concessions was Circa $200,000 and this Capital Gain component was going to cost him in tax circa $80,000.
Like many entrepreneurs, Henry is disciplined in his business and can often neglect his superannuation. Superannuation is a key component in wealth creation due to the low taxing environment and concessions on retirement available. This oversight means I often hear “My business is my superannuation. I don’t trust those retail funds”.
Henry had made only small concessional superannuation contributions and had the ability to carry forward up to 5 years of previously unused contributions cap amounts. This totalled Circa $100,000, and after speaking to his financial advisor we advised him to make this full personal contribution. While the contribution was taxed at 15% in the superannuation fund, Henry personally saved circa $44,000 in personal tax.
Make an effort to review your tax position each year and consider your superannuation as an option to maximise wealth.
Planning Ahead to Ensure Maximised Asset Protection and Tax Reduction
No matter where you are in your business or wealth management journey, it’s never too early or too late to speak to an expert accountant. A meeting could save you thousands in tax due to optimised tax reduction strategies, and thousands in prudent financial wealth management and asset protection strategies.
Bishop Collins – You’re not alone in Tax minimisation, Wealth Maximisation and Asset protection
Reducing your tax burden requires careful planning and expert advice. By understanding the role of a tax accountant, you can navigate the complexities of your unique situation.
At Bishop Collins, we specialise in guiding business owners through every step of tax planning, wealth creation and asset protection.
Ready to start minimising your tax burden? Contact Bishop Collins today for expert advice and support.