Financial Planning Advice For Herbert And Dorothy Evans

Herbert and Dorothy do not have children. They have come to see you to get some financial planning advice.

They want to know whether they have structured their affairs in the most effective manner, and whether there is anything they could (or should) be doing differently. They both have superannuation funds, but haven’t really paid much attention to them in the past.

Herbert operates as a sole trader, running a “Test and Tag” franchise on the Sunshine Coast.

Dorothy undertakes all of the secretarial and accounting duties of Herbert’s business, as well as running her own business as a sales representative for “Endless Life” Supplements.

Your tasks

1. Calculate the net tax payable for Herbert and Dorothy for the 2018/19 financial year. Show all workings. Include Medicare, Medicare Surcharge (if applicable) and any offsets or rebates that may apply.
2. Provide advice to Herbert and Dorothy about merging both of their businesses into a partnership. Show how you have compared the option of merging versus not merging. Show all workings/calculations. Justify your advice.
3. Advise Herbert and Dorothy as to whether they could possibly arrange their financial affairs more efficiently; and whether there are other strategies they could be considering to enhance their short term and/or long term position. (Areas to consider include – superannuation, Estate Planning, Insurance, debt reduction) No calculations are necessary, however you will need to provide details of the potential strategy/ies you are recommending they consider. Justify your recommendations.

Notes:

- Any assumption you make need to be stated.

- Your word limit is 2000 words (excluding calculations, appendices, headers, footers and bibliography).

- Marks will be deducted if you exceed your word limit.

Overview of Herbert and Dorothy Evans' Financial Situation

Individual Taxpayers, who are Resident Australians, are required to pay their income tax for the income 2018-19 at the rates specified by the Australian Taxation Office (ATO), asserts Barkoczy, (2015). These rates are detailed in the table below.

Medicare Levy Surcharge

The rates mentioned in the above table are EXCLUSIVE of the Medicare levy Surcharge which is levied @ of 2% on the NET TAX payable by the taxpayer, asserts Barkoczy, (2013). However, these rates are INCLUSIVE of the changes announced through the Federal Budget for the year 2018-19.

As per the Australian Taxation Office (ATO), the Medicare Levy Surcharge (MLS) is levied on those Australian taxpayers who have not taken out an appropriate Private Hospital Insurance Policy to cover their personal medical expenses. The ATO has prescribed an income threshold for those who DO NOT have an appropriate Private Hospital Insurance Policy, say Deutsch et al, (2011). The income threshold, below which the non-policy holders are not held liable for paying the MLS, is $90,000 for those taxpayers who are holding the status as singles and $180,000 for those taxpayers who have families.

Offsets Explained

If a resident taxpayer’s assessable income is calculated as less than $66,667 for income year 2018-18, the taxpayer becomes eligible for the Low Income Tax Offset (LITO). However, the maximum tax offset which the resident taxpayer can avail is restricted to $445, and is applicable to taxpayer’s whose taxable income is below $37,000. Another provision of the ATO restricts the limitation by reducing the threshold by 1.5 cents for each dollar over taxable income of $37,000, as per CCH, (2015).

Prior to the income year 2018-19, the Low Income Tax Offset (LITO) was the only tax rebate available for the Australian resident individual taxpayers who were having low income. In the Federal budget presented by the government for the year 2018-19, a proposal has been forwarded that in addition to the basic tax-free threshold of $18,200, the applicable amount of LMITO (Low and Middle Income Tax Offset), which was fixed at $445, will be made applicable to all Australian resident individuals whose taxable income reaches $125,333.

Low and Middle Income Tax Offset

The Low and Middle Income Tax Offset (LMITO) is a tax offset introduced as part of the Budget 2018 measures to revise the personal income tax rates. It applies in the years from 1 July 2018 to 30 June 2022. The LMITO applies in addition to the Low Income Tax Offset (LITO). The LMITO will be available subject to taxable income tests as follows:

Case Study Application

In case of Herbert and Dorothy Evans, their Individual Income Statements are annexed under ANNEXURE TO SECTION – 1, LITO or even LMITO is not applicable in Herbert’s case. However, Dorothy can avail a tax offset amount of $530, which is applicable to taxpayers whose assessable income is between $48,001 and $90,000, as per details taken from https://atotaxrates.info/tax-offset/low-and-middle-income-tax-offset/

SECTION – 2: Proposal for Partnership

If Herbert and Dorothy were to convert their existing businesses from sole trader to a partnership, they will first have to apply for a Business Name, Australian Business Number (ABN) and then for tax registrations. A partnership is different from a sole trader, in a partnership the couple will be business partners and will be personally liable for debts of the partnership business, although they will share, in equal proportions, the control and management of the partnership business, as per Nethercott, Devos & Richardson, (2010). The couple will distribute the income or losses from the partnership business among themselves in equal proportions. In comparison to other type of entities, a partnership is inexpensive in setting up and operating. Although partners unknown to each other may go for a written partnership agreement, in case of Herbert and Dorothy this is not essential, as a verbal understanding is equally binding, says Renton, (2012).

Taxation Rates and Offsets for Australian Resident Taxpayers in 2018-19

As partners, Herbert and Dorothy will have to manage their superannuation arrangements as individuals. However, as partners, they can withdraw the contribution for their super contribution, although the partnership firm will have to pay superannuation, at the required terms, to its employees. As partners, assert Smith & Koken, (2011), the Fixed Monthly Drawings which the couple will draw from the partnership business cannot be claimed as deductible expenses for taxation purposes as the amounts which the partners withdraw from the partnership are not considered as wages for taxation purposes. For Taxation purposes, Herbert and Dorothy will not be considered as employees, but they can employ workers, as per Ault, Arnold & Gest, (2010).

Key features

Below are cited the important features of a partnership business to be followed by Herbert and Dorothy in case they decide to merge their individual Sole Trader businesses into a Partnership Firm –

• Partnership firm must apply for an ABN which is to be used for all business deals.
• Partnership is required to register for GST in case the annual GST turnover of the partnership business is above $75,000.
• All income, losses including control of the business will be shared in the agreed proportions among the couple.
• The partnership firm will have its own TFN and will be required to file its separate partnership return annually, which will include all the income and deductions of the partnership firm.
• The partnership firm is not to pay income tax on its profits. The partners are required to report the share earned from the partnership firm as income in their individual tax returns.
• Each partner is liable for paying tax on their earned share from the partnership firm at tax rates applicable for individuals and if applicable, can also avail the small business tax offset.

The only disadvantage of a partnership firm is that the partners have unlimited liability for the debts of their partnership business and each partner is 'jointly and severally' liable for these debts, as detailed by Nethercott, Devos & Richardson, (2010).

Case Study Application

On the basis of the above mentioned details, Herbert and Dorothy can take best advantage of the taxation laws if they plan to merge their businesses into a single entity based on the features of Partnership. This will give them a broader and flexible platform for managing their tax liabilities. This can be seen from the comparative analysis given below –

Hence, it is evident that the couple can save $74,588 on taxes simply by changing the operation mode of their businesses from Sole Traders to a Partnership Firm. Additionally, the couple can also remove the disparities in the expenses which they are presently claiming individually. The partnership system of managing an entity will not only give the couple safety from debt payments, it will also give them the advantage of drawing fixed amounts from the business, without disturbing their capital base, says CCH, (2015). An analysis of comparing their tax liabilities as individuals to their tax liability if they form a partnership entity is annexed under ANNEXURE TO SECTION – 2.

SECTION – 3: Future Plans

To facilitate smooth and efficient operations of their profitable business ventures, the following avenues of channelizing their investments are proposed for Herbert and Dorothy Evans. Some of the sectors, as per Deutsch et al, (2011), in which the couple needs advise are –

• Estate Planning
• Investments in Rental Properties and Stocks
• Insurance Planning and Debt Reduction

In the opinion of this paper, all these sectors can be taken care by Herbert and Dorothy through the establishment of a Self-Managed Superannuation Fund (SMSF). This is the foremost avenue to be adopted by Herbert and Dorothy for their surplus cash as well as surplus profit from business activities. This will also give the couple an added advantage of secure holding of their assets, be it the rental properties or stocks, assert Ault, Arnold & Gest, (2010). The process, working and benefits of a SMSF have been detailed below for the preview of the couple.

• Establishing a SMSF

Establishing a SMSF is done with the sole purpose to provide financial benefits to members, especially after they retire and after their death to their dependents, as per Deutsch et al, (2011). A SMSF is required to have its own Tax File Number (TFN), an Australian Business Number (ABN) and a bank account for carrying out business transactions. Since a SMSF functions as a trust and since minimum two trustees are required, Herbert and Dorothy can easily start a SMSF, according to Barkoczy, (2013).

• Investment Choice

Application of Taxation Rates and Offsets to Herbert and Dorothy Evans' Case

A SMSF will offer the couple the perfect opportunity for planning their investments through a wide range of fixed assets, including investments in Real Estate, Stocks, Other Immovable Assets and even Collectibles. Moreover, as per Nethercott, Devos & Richardson, (2010), a SMSF can be used by Herbert and Dorothy for making investments in most other investment products, including other SMSFs and assets, whether these are located inside Australia or are located overseas, whether they held by listed or unlisted property trusts, including their derivative products such as Dividend Warrants and Options, as detailed by Marsden, (2010).

• Tax Benefits

Herbert and Dorothy will be able to take advantage of the following benefits which are provided exclusively to the SMSFs by the Australian Taxation Office (ATO). In the Accumulation Phase of the SMSF, Herbert and Dorothy will be able to–

• gain tax benefits for their Concessional Contributions which are taxed at a flat rate of 15% in a SMSF;
• get benefit of Government Co-contribution for all their qualifying contributions;
• get investment earning which are taxed at maximum rate of 15% in SMSF;
• pay Capital Gains Tax @10% on assets held for above 12 months; and
• implement their strategies of managing individual members’ tax positions;
• have all their earned income and capital gains exempt from withdrawal tax when they transit to the Pension Phase, as detailed byRenton, (2012).
• Flexibility

The governing rules of SMSF, as per Smith & Koken, (2011), provide their members with flexibility which is not available to other superannuation funds. This flexibility offers tax benefits and a SMSF can acquire business real assets either from another member or from other related parties of the fund, assert Ault, Arnold & Gest, (2010).

• Other Benefits
• Life Insurance

As members of a SMSF, Herbert and Dorothy will be able to get both life and income protection insurance covers. The advantage for the couple from this approach will be that the premium of such insurance policies will be paid by the SMSF and the premium amount is considered as a tax-deductible expense for the SMSF, say Deutsch et al, (2011). Since the ATO has now abolished the Reasonable Benefit Limits, the barrier for members requiring higher life insurance through their SMSF has been removed. A Reasonable Benefit Limit is the maximum amount of the retirement benefit an individual can receive over the individual’s lifetime at a concessional tax rate, says Barkoczy, (2015).

• Effective Transfer of Wealth

SMSF’s inherent flexibility will allow Herbert and Dorothy to make arrangements for facilitating an effective wealth transfer after their death, asserts Renton, (2012). Since the superannuation savings are the largest asset or, in some cases, the second largest asset, after the individual’s family home, it becomes prudent for the authorities to ensure that the superannuation savings of the couple are transferred between generations in an effective manner, asserts Barkoczy, (2013).

• Retirement Income

A SMSF is the right source for paying its members their benefits as a retirement income stream. This also includes the transition from the Accumulation Phase to the Retirement Income Phase. Moreover, as Herbert and Dorothy will be the fund trustees, they can tailor-make their payments for meeting their financial needs, says Marsden, (2010).

Case Study Conclusion

This paper firmly believes that the dispositions made here are for the betterment of Herbert and Dorothy. The SMSF is the single, most effective, source of fund management, which can prove to be a boon for the couple in planning their long-term (as well as short-term) wealth management strategies.

References

Ault, H. J., Arnold, B. J. and Gest, G. 2010. Comparative income taxation: a structural analysis. 3^rd ed. Kluwer Law International, Amsterdam.

Barkoczy, S. 2013. Foundations of Taxation Law 2012, 5^th ed. CCH Australia Limited, North Ryde, NSW.

Barkoczy, S. 2015. Australian Tax Case book, 12^th ed. CCH Australia Limited, North Ryde, NSW.

CCH. 2015. Australian Master Tax Guide 2015. CCH Australia Limited, Sydney, NSW.

Deutsch, R., Friezer, M., Fullerton, I., Gibson, M., Hanley, P. and Snape, T. (2011) Australian tax handbook. Thomson Reuters, Pyrmont, NSW.

Low and Middle Income Tax Offset. Retrieved on 5^th October, 2018 from https://atotaxrates.info/tax-offset/low-and-middle-income-tax-offset/ 

Marsden, S. J. 2010. Australian Master Bookkeepers Guide, 3^rd ed. CCH Australia Limited, Sydney, NSW.

Nethercott, L., Devos, K. and Richardson, G. 2010. Australian taxation study manual: questions and suggested solutions, 20^th ed. CCH Australia Limited, Sydney, NSW.

Renton, N. E. 2012. Family Trusts: A Plain English Guide for Australian Families of Average Means, 4^th ed. John Wiley & Sons, Milton, QLD.

Smith, B. and Koken, E. 2011.The Superannuation Handbook. John Wiley & Sons, Milton, QLD.