With the end of the financial year almost upon us, now is the time to consider how shares can be a tax-effective vehicle.
As an investor, we should be more concerned about after tax profit because that's how much we have in our pockets at the end of the day.
Generally, the thing to keep in mind is that for most people, tax laws can be more beneficial to a longer-term investor.
If you hold on to your shares for more than 365 days, you only have to pay tax on half your gains. So effectively you end up paying half the tax that you would have if you had kept the shares for less than one year.
Keep in mind that the rules are different if you are classified as a trader.
Dividends are taxed at your marginal rate of tax. Dividends can also be a tax-effective way of receiving income.
In Australia, we have a system of dividend franking. So if your dividend is fully or 100% franked, the company has already paid tax on that income to 30%. A fully franked dividend comes with a tax credit.
If you are on a marginal tax rate of less than 30%, you effectively end up paying no tax on that income and may even receive money back from the Tax Office.
If you are on a marginal tax rate of greater than 30% then you usually pay the difference.
With an unfranked dividend, you receive no tax credit with that income. Companies can only pay franked dividends if they have paid company tax in Australia.
A few reasons why they might not pay company tax in Australia are if the company has made profits outside Australia or if they have previous losses to offset against gains.
Investing in shares and receiving income from dividends can be a very tax-effective way of accumulating wealth.
Income investing looks at maximizing sustainable income from a portfolio. But it's more than getting high dividends. It's also about getting a sustainable dividend. That means you need to make sure that the company you are investing in is maintaining profit or growing profit so that you can get your dividends.
Often if companies get into a rough patch, they will start to cancel dividends. As an income investor, that's the last thing that you want from your portfolio.
The great thing about income investing is that you get money whether the market is going up or whether it is going down.
So income investing can act as a buffer against losses when the market is going down.
Income stocks tend to come into fashion in a sideways and falling market.
All in all, the sharemarket can be one of the most tax-effective places to make capital and get income. At the end of the day, what should be most important is how much we get in our pockets. Luckily, the Australian tax system tends to reward long-term investors.
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Happy trading!
Julia Lee Equities Analyst Bell Direct
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