How to make $1 million a year and pay no tax
If you read about the 60 Australians who make more than $1 million a year but don’t pay taxes, the idea is probably to get angry and demand changes to the tax system.
That probably won’t get you very far, but what if we took the alternative approach and asked how many of the strategies employed by these low-tax millionaires can be adopted by people on more normal incomes?
Some of the more esoteric and more expensive ideas used by the wealthy are definitely out, such as $250,000 a year, no less) against the Australian Inland Revenue, which apart from anything else breaks that very wise and valuable advice, never “the town hall to fight”.
Some wealthy tax systems are best left to the rich
Similarly, all those international entities and asset shuffling between family trusts and corporations are probably out too – they’re just too expensive to set up and maintain for the small tax savings that would apply to anyone on more modest incomes.
However, there are some strategies that are directly applicable and cheap enough to apply to low-income earners and get them to lower their tax bills like Kerry Packer did in his heyday.
Charity can pay off
Perhaps the most surprising tactic is to be generous to charities.
This was the largest single deduction the 60 Income Millionaires claimed — a total of $114.4 million, averaging $1.9 million each.
As long as the charity or political party you support is tax-deductible, this deduction is an easy and worthwhile way to reduce your annual tax burden.
Obviously you lose access to the money donated, but perhaps these big donors get some return for the money in the form of high-ranking influence.
Gearing strategies and stamped dividends reduce taxes
Some of the other really big deductions for this group were dividends and interest payments, at a massive $16.9 million and $14.3 million, respectively.
These deductions use two very well-established principles that can be directly applied to those on much lower incomes.
Many stock dividends in Australia are fully franked, which basically means that the full amount of corporate tax has been paid on the amount of profits distributed.
That is, if your personal tax rate is equal to or less than the corporate tax rate, you actually get a tax refund on the difference.
If your marginal tax rate is zero, you’ll actually get a full refund of that postage credit after you file your tax return.
Even if you have a higher tax rate – which none of these 60 do – the Franking Credit goes a long way toward reducing taxation on those income streams.
Interest on assets is tax deductible
For interest payments, money paid as interest on a loan to purchase a business asset, such as real estate or stocks, is generally deductible from the income from that asset, and in the case of negatively biased investments where interest exceeds income, this is be the case also result in a tax refund.
For example, when these policies are combined with a loan that is used to purchase large company shares, which then pay post-paid dividends, the tax effect is amplified – especially considering that the capital gains tax on these types of assets is much lower than the traditional income tax Asset held for more than one year.
There are obvious risks to such an approach – using gearing (loans) for any investment increases returns, but it also increases risk, sometimes dramatically.
If you’re using margin lending and your stock portfolio dips far enough, you’ll either have to raise a significant amount of extra money very quickly (a margin call) or sell a lot of stocks at what may be the worst possible time.
Many of these non-tax millionaires also likely own shares in their own small businesses that can be structured to pay stamped dividends, and can also take advantage of immediate corporate tax write-offs that were common during the pandemic stimulus days.
Generous tax regimes are controversial
Obviously many people would like to change these rules as they see them as tax dodges that primarily benefit the wealthy, but so far measures like the capital gains tax rebate and negative gearing have not garnered much political capital to fuel the outrage.
Perhaps the best, but arguably least popular, strategy for taking on these earning millionaires is to grow old.
Getting older can cut your tax bill
Once you reach age 60-65, income tax can drop dramatically because up to $1.7 million in retirement assets can be used to pay for a pension that is completely income tax-free.
So, for example, if you’re 65 and receive a $1.7 million pension in Super, you could earn an income of $68,000 a year or much more if you choose to exceed the minimum drawdown , totally tax-free.
Top that off with fully paid dividends from stocks and you can quickly build up a very sizable annual income without incurring any taxes.
In fact, if at any age you had about $25 million invested in stocks that paid a 4% dividend, fully paid, you could have a substantial corporate tax credit for income of $1 million per year earn.
For those with more modest investments and goals — that’s almost all of us — the same idea can be scaled down, with the added benefit of those credits for paid corporate tax becoming a source of income after retirement every year as you file your tax returns .
In summary, the three most appropriate approaches to legal tax reduction that can be used even by people with fairly modest incomes are maximizing super, holding stocks that pay dividends stamped, and using loans ( Gearing) for investments.
Making tax-deductible charitable donations also helps reduce taxes, but is less likely to be an option for those on lower incomes.