You earn more money; you pay more tax. So far, so fair.
But what’s not so fair happens when your wage rise bumps your earnings into a higher tax bracket, even though your pay increase may only be in line with inflation. This is known as ‘bracket creep’, and the combination of inflation and a higher tax rate can mean you have less purchasing power than before your pay rise.
However, you can avoid bracket creep by putting your earnings to work in a way that means they won’t be consumed by tax. Here’s how:
Concessional super contributions
Shift some of your income from a higher marginal tax rate into the concessional superannuation environment, where it is taxed at 15%. You can do this by salary sacrifice via your employer, or by making deductible personal contributions of no more than the concessional cap.
Company or trust structures
You may have the opportunity to receive income through a company or a family trust. Small-to-medium-sized businesses (annual turnover of less than $50M) are taxed at 25%. Family trusts can distribute income to family members on a lower tax rate. Be aware, though, of compliance costs and anti-avoidance rules.
Move income or expenses into a different year
Consultants, business owners and investors may be able to control the timing of taxable income and tax-deductible expenses. Income could be deferred until the following year if you expect your income to fall. It’s also possible to claim current-year deductions for some types of prepaid expenses.
Negative gearing
Rental property losses and the cost of borrowing to invest in shares can be offset against your employment income, in a situation known as ‘negative gearing’. This could lower your marginal tax rate.
However, negative gearing should not be your primary investment motive: prioritise long-term returns such as capital gains.
Capital gains timing
If your marginal tax rate is rising, it’s more important than ever to ensure that you qualify for the 50% capital gains tax discount by holding assets for longer than 12 months, or get a partial exemption for a rental property that was at some time your main residence. Spread asset disposals over several years if possible, ideally into years with lower income from other sources.
Permitted income splitting
Although Australia, unlike some other countries, does not allow joint spouse tax returns, there are permitted ways to split income and thereby lower marginal tax rates, beyond the family trusts already mentioned. These include:
- Investing in the name of a lower-income spouse.
- Paying your spouse a reasonable amount as a genuine working employee of your business, after obtaining financial advice about Personal Services Income (PSI) rules.
Tax offsets and rebates
Offsets and rebates don’t lower your marginal tax bracket, but they do reduce the amount of tax you will pay. You may be able to claim an offset for making a contribution to your spouse’s super, as well as an income-tested private health insurance rebate.
Tax-effective benefits
If possible, negotiate tax-effective benefits with your employer if you can afford to take them in lieu of taxable income increases. These might take the form of employer super contributions above the mandated 12% Super Guarantee rate, or fringe benefits such as a company car (although this may increase your Medicare levy or affect your eligibility for other government rebates or benefits).
Stay informed about tax changes
Plan ahead by staying up to date on proposed tax threshold adjustments.
Get professional advice
Don’t be too alarmed if a pay rise puts you in a higher tax bracket. Remember that it’s only the marginal extra income that is taxed at a higher rate, not your entire salary. But you can take a strategic approach by getting professional financial advice to help you shift your income into lower tax environments and maximise the effect of your legitimate deductions.
