Why am I paying tax (Australia)?

By Jarrod Rogers CPA

For most taxpayers in Australia, lodging a tax return means getting some money back from the government. In fact, according to statistics from 2009, 84% of taxpayers received refunds, and of the rest, 4% had no tax to pay.

So it comes as a shock to find out you have to pay tax to the government at the end of the year. It’s particularly annoying when everybody else is gloating about their tax refund.

Like your mate, Bazza, who reckons “My tax guy claimed all these dodgy loopholes, and I got a $3,000 return”, as he gets in his supposedly tax-deductible car to drive to the casino to “invest” his windfall.

Why am I paying money on my tax return?

Before I go off on a tangent about how irritated I get at people who give outlandish tax advice (e.g. car salesmen, property spruikers and, sadly, some tax agents) let me give you a list of reasons you are paying tax.

1. You are self-employed.
2. You have a HELP/HECS debt and you didn’t tell your boss about it
3. Your payroll officer is a cabbage (and calculated your tax incorrectly)
4. You had investment income, such as bank interest or rent
5. You had two or more jobs where you claimed the tax-free threshold
6. You made a capital gain, e.g. sold shares, sold property
7. You don’t have private hospital insurance and your income is over the Medicare levy surcharge threshold

The common thread of all of these is that you haven’t paid enough tax during the year, so you have to pay tax at the end. It makes more sense if you understand how the tax system works.

How does the Australian tax system work?

The tax system in Australia is a “pay-as-you-go” (PAYG) system. This is the same concept as PAYE (pay as you earn) in other countries.

As much as possible, the ATO collects tax from taxpayers throughout the year, rather than in an annual tax assessment. This is why tax is deducted from your wages before you get paid.

So at the end of the year, you should have enough PAYG credits to cover your tax assessment.

Let’s say you make $78,000 for the year, applying 2012-13 tax rates. You pay tax as follows:

• Income tax: $16,897
• Medicare levy (1.5%): $1,170
• Total tax: $18,067

During the year your employer will deduct tax based on a formula. A salary of $78,000 is $3,000 per fortnight. The tax per fortnight is $696, which makes the total tax for the year: $18,096.

That would result in you getting a tax refund of $29. Of course, there would normally be deductions to claim to reduce your income, but the point is this: the PAYG system is designed so that you break even on tax at the end of the year. The system is not designed to provide big refunds or create big debts.

How to get a big tax refund

In fact, the only ways to get a big tax refund are:

1. you have a lot of deductions (which means it costs you a lot of money for the privilege of doing your job)
2. you have deductible investment losses (e.g. negative gearing on shares or property)
3. you overpaid tax during the year

The most common reason for people getting large tax refunds is that they pay too much tax. Let’s continue our example from above. Imagine two taxpayers, Jack and Jill. They have the same job, the same salary. Jack has the correct amount of tax and is entitled to a tax refund of $29.

But when Jill fills out her TFN declaration when starting work, she answers “no” to the question “do you want to claim the tax-free threshold?”. This means her fortnightly PAYG tax is $964, and her annual PAYG tax is $25,064. Jill is due a refund of $25,064 -$18,067 = $6,997

So Jack gets a $29 refund from the ATO, and Jill gets $6,997. Who is in a better tax position? (… think about it… come on… don’t just wait for me to tell you… you’re only cheating yourself). Answer: neither of them!! They are both paying precisely $18,067 in tax. One receives less pay during the year, one receives a lesser tax refund at the end of the year. The only difference is timing.

Think of it this way: a tax refund is like getting change from a shop. Let’s say you buy a bottle of milk for $2 and pay with a $5 note. You get $3 change, right?

If you buy the same bottle of milk and pay with a $50 note, you get $48 change. The milk costs you $2 either way. But if you give a bigger note, you get more change. You don’t rush home and tell your wife “I got a massive milk refund.” But that’s exactly what people do with tax refunds.

Remember, a tax refund is your own money, paid back to you. It’s not magic, and it’s not a handout.

Having said that, if you’re a shop-a-holic or bad at saving, then overpaying tax to get a big refund makes sense. It guarantees a big refund each year, and I have met several clients who use the tax system as a means of “forced savings”.

How do I stop paying tax on my tax return every year?

So how do you stop paying tax at the end of the year? You can pay more tax during the year, or you can reduce your taxable income.

Let’s take the example of Jack who earns $78,000 to explain a few scenarios.

HECS/HELP debt: If Jack has a HELP debt he would need to pay an extra 7% of his income as a compulsory repayment. That means: 7% x $78,000 = $5,460. The $29 refund becomes a $5,431 debt. Jack needs to inform his employer he has a HELP debt, and may need to re-do his TFN declaration. Alternatively, he could pay off his HELP debt as a lump sum. If he does so before 31 December 2013 a 5% early payment bonus will apply.

Two or more jobs: Again, a new TFN declaration will be required to ensure the tax-free threshold is not claimed for more than one job. If you have multiple casual jobs, it’s safer to not claim the tax-free threshold at all.

Investment income: Let’s say Jack has $2,000 in bank interest in addition to his $78,000 salary. He now has a taxable income of $80,000, which means a tax of $18,747. However, his PAYG stays the same at $18,096, and he owes $651 when he lodges his tax return.

Jack has a few options. He can get used to owing money each year, or he could ask his boss to deduct $30 per fortnight in tax to put himself in a refund position.

Alternatively, he could transfer his savings into superannuation (if he was close to retirement) as the interest is only taxed at a maximum of 15% (compared to 34% in his own name). If Jack was saving for a first home, he could open a first home saver account where the interest would be taxed at 15% and he may be eligible for a 17% government bonus.

Capital gains: If you make a capital gain, it is inevitable that you have to pay Capital Gains Tax (CGT). You can’t change that, but you should speak to us prior to major CGT events for advice on arranging the timing of the sale, offsetting capital losses and what expenses can be included as part of your CGT “cost base”.

Medicare levy surcharge: Taxpayers earning over the income threshold are liable for the Medicare levy surcharge. For more information see: https://www.beyondaccountancy.com.au/medicare-levy-surcharge/

How do I check I am being taxed correctly?

Finally, if you think your payroll officer at work is making a mistake, how do make sure you are being taxed correctly?

You simply need to check the ATO’s tax withheld calculator. This is a free online tool that allows you to enter your details and your gross salary to calculate your tax correctly.

Go to www.ato.gov.au and search for “TWC online”. Use the individual non-business calculator.