It’s that time of year again, and I will no doubt be having the same conversation with many of my children’s friends who are new at lodging tax returns. They will want my help to get as much tax back as possible and explain why their expectations do not necessarily match the reality of the tax refund. So, to save time and reach a larger audience, I am writing this for you, the first time taxpayer.
Tax accountants wonder why the fundamentals of tax are not taught in school, but if you are like any other normal kid, I am sure a lesson on tax would have made little impact on your understanding of the Australian tax system. Your mind would have been drifting off to something much more exciting because let’s face it, tax is boring. That is until it becomes interesting to you when there might be something in it for you. Yes, I bet you already have your anticipated tax refund spent.
How is that mystical refund calculated? I am sure you have plenty of questions all of which are completely normal. In fact, I am still explaining this to people who have been lodging tax returns for many years. Tax can be complicated to understand. There are plenty of older people who are as confused by the tax system as you are. Perhaps you should get your parents to read this as well.
Lodging your first tax return is a very grown up thing to do. I see many parents taking a step back when it comes to organising your tax return. It is one small act of responsibility that will set you on a good path as a tax paying citizen. Lodging your tax return is one of those things you have to do each year. It does not have to be scary, but if you leave it too long or ignore it altogether it can become an unpleasant experience (like going to the dentist). Fortunately, in most cases your early tax returns will result in refunds encouraging you to attend to this life task each year.
Let’s break down some myths so you can feel a little educated when it comes time to do your tax.
Myth 1 – I hear that you get all your tax back the first time you lodge a tax return
Sometimes this is correct, but the ATO do not see you differently to any other taxpayer in Australia. You don’t get a special exemption from paying tax just because it is your first time. Tax is calculated on the total income you have earned for the year. If you were fortunate enough to have earned income that takes you above the tax free threshold of $18,200, you will be contributing some of your income to the Australian Government in the form of tax. Many first time tax payers have not earned a lot in their first year, so they may get all their tax back, but it is not a given.
The way your tax is calculated is quite simple in theory. You calculate all of your income from various sources, including wages, interest, dividends and any work you do as a sole trader on an ABN. You then take away any deductions that the government allows, and this gives your taxable income. There is a formula applied to your taxable income to work out how much tax you need to pay. This is compared to the tax that has already been taken out of your wages. If you have had more tax taken out of your wages than needed, you get a refund. If you have had less tax taken out of your wages than needed, you need to pay. This is the same for every taxpayer.
Myth 2 – If I buy some thing that I can use as tax deductions, I will get that money back
Not exactly. A deduction reduces the amount of income that you have earned and this means the amount of tax you need to pay on that income is a little less. The amount of tax you will get back on your deduction is based on your marginal tax rate (I will explain that later). If your income is around $30,000 for the year, your marginal tax rate is 19%. This means you will get back 19% of the expense.
If your income is $18,000 for the year, your marginal tax rate is 0%. You guessed it you will get back $0 for your tax deduction. You should never buy anything just for the tax deduction. There should always be some other reason you are spending your money. The tax deduction may be an advantage but should not be the only reason you make a purchase.
Your refund will be based on the amount of tax your employer has taken out of your income. The ATO do not mystically give refunds just because you purchased something. If your employer did not take any tax out, there is nothing to refund. The best you can do is get back the tax that has been taken out of your pay. You will not get any more tax back than that.
Myth 3 – My friend got heaps of tax back this year, I should get the same shouldn’t I?
Although tax is calculated using a formula, everyone’s circumstances are different. Your income and deductions are not going to be the same as your friends, they are unique to you.
It is also possible that your tax is calculated with a slightly different formula to that of your friends. If you have a Study Assist debt (eg HECS) and you go above a certain income level you will start to pay some of the debt back. Private health insurance, Medicare Levy and Medicare Surcharge may effect the overall tax calculation.
Myth 4 – I think I have earned enough to move into a higher tax bracket. This means I am going to be higher tax on all of my earnings
This is a very common misconception that I discuss with taxpayers all the time. Tax is calculated on a scale that increases the amount of tax you pay as your income gets higher. However, you only pay the higher tax rate on the income that is earned at the higher rate.
Let’s say your taxable income is calculated at $50,000 for the year. On the first $18,200 you pay no tax at all. This is the same regardless of how much you earn. Between $18,201 – $45,000 you will pay 19 cents in the dollar and then you will pay 32.5 cents in the dollar between $45,001 – $50,000. On top of this you will pay 2% in Medicare levy. The total of all of this is $7,796 + $1000 (Medicare Levy) = $8,786. This is very different to thinking you will pay 32.5 cents on all of your income which would mean you would be paying $17,250 in tax. That would be really bad.
So yes, you will be paying tax at a higher rate, but only on the income that relates to that higher tax bracket. It is always better to earn more money than less. There is no reason to reject a higher income because you will be paying a higher rate of tax.
The tax bracket your income falls into is known as your “marginal rate”. In the case of a $50,000 salary your marginal rate is 34.5 cents (32.5 + 2 cents for Medicare Levy). This means that any tax deductions will give you back 34.5 cents in the dollar.
Myth 5 – I have private health insurance so I should not have to pay Medicare
Medicare is levied on all taxpayers unless your income is very low, or you are exempt for a special reason. Private health insurances prevents you from having to pay Medicare Surcharge, not the Medicare Levy.
Medicare Surcharge is extra tax that you pay if you don’t have private health insurance and your income is at a higher level.
Myth 6 – My employer is paying my Study Assist Loan (eg HECS) as a deductions from my pay so why is it on my tax return?
Your employer does not know how much you owe on your Study Assist loan, only that you have one (because you have told them hopefully). They are taking extra tax out each pay to cover this, but the calculation of how much needs to be paid off your loan only happens when your tax return is done.
If you have not told your employer that you have a Study Assist Loan and you earn enough to start paying it back, you will probably end up with a tax bill. Make sure you tell them so they can take some extra tax out. It may take a few years to earn enough to start to pay your loan back but the debt will not go away. It can be a nasty surprise if you have not informed your employer about it and not enough tax has been taken out.
Hopefully this has helped your understanding a little but I am sure you will have many questions. Sometimes it is good to get a little help with your first tax return or take some time to read up on what you can and cannot claim based on the work you do.
The ATO has some excellent guides to help you based on your occupation. Find the one relevant to you using the link below.
Finally, remember to be honest in what you tell the ATO and keep records of your receipts or calculations. Get into some good habits and lodging your tax return will be a breeze for years to come.