We all love our tax deductions, right! “I’m paying too much tax, how do I reduce it?”
I have these conversations with my clients all the time. Unfortunately there is a great myth when it comes to tax deductions that not everyone is aware of.
There are lots of opportunities out there, for better or worse, that offer tax deductions as a “benefit”. We often see these tax deductions mistakenly being used as THE reason for making a significant financial decision. This might be for an investment, a business trip, a novated car lease packaged through work, donation, personal insurance or some other form of spending.
Let’s get one thing clear…
When you get tax back through your tax return, it’s because you’ve already spent the money… AND you only get a portion of it back
If you were already going to spend this money, then go bananas and find every legal loophole to get that tax back. However, if you’re yet to spend (invest, donate, lease that car) and are weighing up your options, then you need to pause and make sure it’s for the right reasons.
Here are the 2021-22 personal tax thresholds in Australia*:
*to save confusion we’ve omitted the Medicare Levy of 2%
So if you earn $100,000, the $55,000 you earn above $45,000 is taxed at 32.5%. Therefore, if something is tax deductible for you, like a $10 donation, you will receive $3.25 back when you do your tax return. Effectively you’ve lost (or in this case donated) $6.75.
The tax deduction conversation can sometimes go a little something like this:
Confused investor chasing gold at the end of mythical tax rainbow: “Guess what! I’m buying an investment property, it’s tax deductible!”
Concerned Friend: “Great, where is it? Is it going to grow in value and give you a good rental return?”
Confused Investor: “Dunno, but I’ll get a better tax return each year!”
What they’re really saying is:
“Guess what! I’m going to drop a dollar! But it’s ok, I still get to pick up 37 cents!”
A tax deduction can help make an investment more affordable, but if that investment doesn’t perform, you still lose.
Unfortunately I see this with new clients all the time. Many of us have fallen into the trap of using the idea of a tax deduction as an excuse for purchasing something. It’s like a discount in a way.
The trouble is, it’s this type of behaviour that will lead you into the false sense of security feeling like you have your finances under control. That feeling is dangerous if it leads you to make more decisions based on false presumptions like this.
Stop and ask yourself whether you’re really benefiting. If you’re not sure, speak to a professional who can help.
Let me shout this out one more time; if you’re doing something purely for the tax deduction, please drop it.
Investing, purchasing insurance, leasing a car or making any other decision that involves spending to get a tax deduction? Do it because it’s a good idea that you would have done without the tax benefit, and now you can claim that spending back as a bonus.
I hope this helps to clear up the myth and ensure you think twice about chasing tax breaks that might not be all that helpful. Remember that when you have a large amount of tax to pay, this can only ever come about because you’ve made good money. I’m not saying don’t go hard trying to legally retrieve as much of this as possible, just do it with options that are still beneficial.
What tax benefits are you currently receiving and which ones are you not sure about? Let us know in the comments.
I’m sure it’s no surprise that people ask me about the benefit of having an ongoing relationship with a financial planner. The easiest way to sum it up is it’s like having a coach to help you make decisions. Every major life decision has a financial impact. It’s pretty massive. This is where the coaching aspect comes into play. If you haven’t defined what financial success looks like for you, or if you’re struggling with how to get there, this is when the service makes sense and will be highly valuable for you.
If you want some help finding tax deductions that are going to help you, or if any of this post has confused you, hit us up. I’ll be happy to help!