Sunday 24 June 2007

Tax Reduction - Part 2

Interest and Dividends are simple income items to calculate, with the only wrinkle being where a bank account is in joint names with DW I have to count half the interest earned on my tax return. This year I'll have earned more interest than usual, due to having a sizeable amount of 0% APR money invested from balance transfer offers. I usually don't leave too much cash sitting in interest bearing accounts as it is more tax effective to invest the money in high yield shares that pay fully franked dividends. With franking credits you have to declare the value of both the dividend received and the company tax paid, but you get a tax credit for the company tax that was paid. If your marginal income tax rate is less than the 30% company tax rate you will end up getting the surplus franking credit refunded.

For dividend income I keep all the dividend statements in one folder as they come in during the year, and also record the amounts into a spreadsheet. This makes it easy to spot if a dividend statement has gone missing, as there won't be the usual two dividends paid during the year. I've tended to less participation in dividend reinvestment schemes over the years - a combination of the extra paperwork required to keep track of the individual lots issued and the resultant complications in eventually calculating the capital gains when the stock is sold, and the phasing out of dividend reinvestment discounts by companies. Back in the 80s and 90s it wasn't unusual for DRPs to offer a discount of 5% or more of the average share price when issuing stocks under a DRP. These days most companies don't offer any price discount, so the only saving is the lack of any brokerage fee (but this is also not worth much now that online brokerage fees are so low). I still participate in a few DRPs where the number of shares issued is rounded up to a whole number. With small holdings the difference between getting 4.2 and 5 shares issued can significantly boost the dividend yield.

I also get all my dividends paid electronically into the one savings account, so it is easy to reconcile the dividend payments on my bank statement with my dividend spreadsheet. If any dividend statement has gone missing it will still appear on my bank statement, although I'll then have to do some research to check if the dividend was fully franked so I can compute the franked and unfranked components of the dividend payment and the corresponding franking credit.

If everything reconciles I can simply copy the spreadsheet totals of franked dividend, unfranked dividend, and franking credit into my eTax return. I also print a copy of the spreadsheet and store it and my dividend statements in the Tax Pack in case I eventually get a tax audit.

If I didn't manage my finances in a tax effective manner my salary income and my dividend income would combine to push me into the 42% tax bracket. As it is, using salary sacrifice and margin lending I end up with a total taxable income significantly less than my salary income alone would be. This means that my marginal tax rate is 30% (which applies to interest etc) and capital gains (held over 12 months) are taxed at only 15%.

Next - "Other" income in the Tax Pack Supplement

Enough Wealth

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