28 Apr Tax 101: Tax Basics Explained
We all pay tax to help ensure everyone in the community has access to basic services.
Love it or loathe it, tax is one of society’s most important functions. It helps pay for schools, hospitals, roads and many of the basic services we need to go about our lives. It’s important to understand how it works, so you can make sure you pay the right amount of tax.
What is tax?
Tax involves a monetary contribution from individuals and organisations to local, state and federal governments, who use the funds to pay for the huge array of services the community needs to operate.
“Taxation is the cost of a civilised society. It pays for hospitals, ambulances, police officers, roads and all the essentials we rely on governments to provide,” explains Maree Richards, Australian Unity Trustee Limited’s Head of Tax Services.
Maree goes on to explain that without tax, it would be up to individuals and businesses to pay for essential services on a commercial basis. This would make these services much more expensive and harder to manage. For example, it’s likely many more roads would have a toll charge if they were provided by the private sector, and that many medical procedures would be unaffordable to most people. So, if we all pay our taxes, it means everyone in the community has more equal access to all the services we need to survive and thrive.
Who pays tax?
Everyone pays tax in different ways. We pay tax on the income we receive, the products we purchase, and the properties we own. High-income earners pay more tax than people on a lower income level.
How is tax calculated and collected?
There are a number of different ways tax is collected:
- Goods and services tax (GST): Individuals and most organisations pay a 10 percent GST on most products and services they buy. Businesses offset this against the GST they charge on the goods and services they deliver. GST is collected by the Australian Taxation Office and apportioned between each state government.
- Income tax: Individuals and most organisations pay tax on the income they receive. The more money an individual earns, the higher the rate of tax. This is known as the progressive income tax system. On top of this, tax payers contribute 2 percent of their taxable income to Medicare. The first $18,200 an individual earns is tax free, which is known the tax-free threshold.
There are many other taxes as well. Council rates pay for services such as garbage collection and local libraries. Stamp duty is levied on property purchases, which pays for state government–funded services, such as schools and hospitals. Businesses that pay more than a certain amount in salaries also incur payroll tax, which helps to pay for state-government services.
How can I reduce the tax I pay?
One of the ways to reduce tax is to ensure that you record and maintain records of the goods and services you purchase to produce your assessable income. You may then be able to claim a tax deduction for these items. Depending on your individual circumstances you may be able to delay or bring forward a necessary purchase to maximise the tax savings.
Knowing what you can claim is key, says Maree. “It’s good to have an understanding what you’ve had to do to necessarily generate taxable income. You should also ensure that you do not enter into a transaction where the predominant purpose is to reduce your tax. For example, a tax deductible superannuation contribution it a great way to save tax personally, but this is not the predominant purpose of the transaction as you are also providing for your retirement.
But it can be a false economy to buy items just to be able to claim a tax deduction. For instance, if you pay tax at a rate of 30 percent, you need to spend $1 just to save 30 cents, so you’re out of pocket by 70 cents.
It can, however, make sense to buy goods and services to be able to claim a tax deduction if the expense will help generate more income. For instance, many people pay fees to become a member of a professional body because being a member allows them to charge more for the work they do.
There are many other regular expenses you may be able to claim as tax deductions to reduce the amount of tax you pay. An example is driving your vehicle for work — you can document how much driving you do for work and claim expenses, such as fuel, car repairs and servicing, and depreciation on your vehicle. If you work from home, you can also claim a proportion of your expenses, such as energy and phone bills as tax deductions.
It’s also important to make the most of changes in your assessable income to ensure that you pay tax on asset sales at the best possible time. Investment properties are an example, if you sell the property for more than you purchased it for, you will have a capital gain. The tax payable on the capital gain will be determined by adding the gain to the other assessable income you receive in the financial year. If you sell the property when your other assessable income is lower, for example when you have retired, then your marginal tax rate will be lower and the tax payable on the capital gain will be lower.
“That’s effective tax planning. The idea is to take a long-term approach to strategic tax planning and incorporate it into your wealth creation plan over the long term,” Maree says.
Tax is a necessity, but a solid understanding will help to better meet your obligations and make the most of any opportunities.