48 – Pre-paying expenses and costs
Pre-paying deductible expenses is a tax planning perennial.
The idea is simple: the financial planner looks around in June, identifies expenses coming up in the next 12 months or so, and pays that expense now. Rent, interest, stationery, advertising and electricity bills can all be pre-paid before 30 June each year.
Pre-paying a deductible cost brings the tax benefit forward by one year.
To be frank, there is usually not much in it. It’s a timing benefit, not a permanent benefit. If you pre-pay deductible costs of say $10,000, at a tax rate of 30% you defer tax of $3,000 for one year. At an interest rate of 5% you save $150….
Big deal. Its usually not worth the bother. But there can be more in it if you expect your tax rate to fall next year. Claiming the deduction at a higher tax rate means you also get a permanent benefit equal to the difference in the tax rates, times the amount paid.
Deductions can only be claimed for 12 months of pre-paid expenses.
Capital costs under $20,000
Most financial planning practices turnover less than $2,000,000 a year. This means they are classified as “small business entities” for taxation purposes.
SBEs can claim a deduction for the full cost of capital assets in the year they are acquired, rather than spreading that cost over a number of years under the depreciation rules.
These rules apply from May 2015 and were part of the Government’s budget statement for 2015.
Help me (said) Rhonda
An example may help. Rhonda is a Dover adviser. She watches her pennies closely. In June 2015 Rhonda realized her taxable income (after super) was going to be $100,000. Rhonda is tax astute, and had read Dover’s tax planning for financial planners materials.
Rhonda decided to buy a new second hand car (a Little Red Coupe) costing $19,999 on 30 June 2015 for her daughter, so she “could get around”. (With apologies to the Beach Boys.)
Rhonda claimed a deduction for the full cost of the car, $19,999 in her tax return for the year ended 30 June 2015. The purchaser was Rhonda’s practice trust.
This deduction reduced Rhonda’s taxable income to $80,001, pushed her into a lower tax band and saved her $8,000 tax/cash. Under the old depreciation rules Rhonda would have had to depreciate the $19,999, ie spread it, over her next five tax returns, with no deduction in the 2016 year.
Rhonda paid for the car using her practice’s line of credit and kept her cash for paying off her home loan, as explained in Gearing your practice. This mean Rhonda got the tax saving before she paid any cash out.
Rhonda’s daughter is defined to be an employee of Rhonda’s practice under the FBT rules, and there is no limit on the number of company cars able to be provided to an employee. This meant all the running costs were tax deductible. This is explained in Tax deductible cars.
Rhonda let her daughter have a company credit card, addressed to her practice, to pay for petrol and similar operating costs. This is a simple expedient which helps make sure all costs are substantiated and deducted appropriately.