The Hidden Cost of the Company Tax Cuts
As alluded to in Part 1 on the Company Tax Cuts, coupled with the reduction in rates comes a reduction in how much tax credits a company may pay out to its shareholders.
This means the shareholders, usually the individuals behind the business, pay more tax than they would have had they received the additional tax credits prior to the changes.
Lets illustrate –
A couple years ago, Company A earned $100,000 profit, and paid tax at the company tax rate of 30%.
That means $30,000 tax paid, leaving $70,000 profit left to be distributed to its shareholders.
However, it didn’t distribute the after-tax profits straight away, it waited a couple of years.
By the time it finally does make the distribution (pay a dividend) its applicable tax rate is now just 25%.
The new rate applies not only to income earned in that year, but also to the tax credits it can attach to its dividends paid in that year.
So now it pays a dividend of $70,000 (the profits it had retained) but instead of being able to attach $30,000 of tax credits as was the case in the past, it may now only attach $23,333 (($70,000 / (1 – 25%)) x 25%).
Assuming the recipient of the dividend is on the top marginal rate (which has remained unchanged throughout this time at 45% plus Medicare Levy) they have to pay the difference (top up tax) between the company rate and their rate of 45%.
But the difference is quite a bit bigger now than it was. So the top up tax is more than it would have been. In fact, the shareholder will pay an additional 24% in tax! And worse, the $6,667 of tax credits left in the company ($30,000 – $23,333), will likely become stuck there, unable to ever be accessed!
Planning Can Minimise the Impact
Now don’t despair entirely.
There are ways to manage your dividend strategy and minimise the impact on you and your cashflow.
At CapitalQ, we have already commenced planning for these changes with our affected Clients, ensuring their remuneration strategy achieves the best result possible.
If you are not part of the CapitalQ Community, hopefully you have also already heard from your accountant in this regard. And if not…
(Remember, everyone who attends a Free, No Risk, Initial Consultation receives three entries into our Business Booster Competition for a change to WIN a $100,000 business cash injection, no strings attached. Just think how your business growth will be boosted with a $100k cash injection!)