How to make $1 million a year and pay no tax

When you read about the 60 Australians who earn more than $1 million a year but don’t pay any tax, the reaction is probably to start getting angry and demand changes to the tax system.

That probably won’t get you too far, but what if we take the alternative approach and ask how many of the strategies used by these lowly taxed income millionaires can be adopted by people on more ordinary incomes?

Some of the more esoteric and expensive ideas used by the wealthy are definitely out, such as paying fees (an average $80,000 a year) to your tax accountant so you can get a whopping tax deduction for that and likewise for taking legal action (an average of $250,000 a year, no less) against the Australian Tax Office (ATO), which apart from anything else is breaking that very wise and worthwhile advice never to “fight city hall”.

Some wealthy tax schemes are best left for the rich

Similarly, all of those international entities and shuffling of assets between family trusts and companies are probably out too – they are just too expensive to set up and maintain for the small tax savings that would apply for anyone on more modest incomes.

However, there are some strategies that are directly applicable and cheap enough to apply to lower income earners and have them cutting their tax bill like Kerry Packer did in his prime.

Being charitable can pay off

Perhaps the most surprising tactic is to be generous to charities.

This was the biggest single deduction the 60 income millionaires claimed – a total of $114.4 million which averages out at $1.9 million each.

As long as the charity or political party you support has tax deductible status, this deduction is a straightforward and worthwhile way to reduce your annual tax bill.

Obviously, you lose access to the money donated but perhaps these big donors get some return on the money in the form of influence in high places.

Gearing strategies and franked dividends lower tax

Some of the other really big deductions for this group were around dividends and interest payments, at a massive $16.9 million and $14.3 million respectively.

These deductions use two very well-established principles that can be directly applied to those on much lower incomes.

Many share dividends in Australia are what is known as fully franked, which basically means that the full amount of company tax has been paid on the amount of profit being distributed.

That means if your personal tax rate is at the company tax rate or lower, you actually get a tax refund on the difference.

If your marginal tax rate is zero, you actually get the full amount of that franking credit paid back to you after filing your tax return.

Even if you are on a higher tax rate – which none of these 60 are – then the franking credit will go a long way to reducing the tax on this income stream.

Interest on assets can be tax deductible

For interest payments, money that is paid in interest on a loan to buy a business asset such as a property or shares is generally deductible against the earnings of that asset and in the case of negatively geared investments where the interest outstrips the income, this will result in a tax refund as well.

When these policies are combined with, say, a loan used to buy large company shares that then pay out franked dividends, the tax effect is magnified – particularly when you consider capital gains tax on these sorts of assets is much lower than conventional income tax if the asset is held longer than a year.

There are obviously risks to such an approach – using gearing (loans) on any investment increases rewards but also increases risk, sometimes dramatically.

If you use margin loans and your share portfolio dives far enough, you either need to come up with a significant amount of extra money to tip in very quickly (a margin call) or will need to sell a lot of shares at possibly the worst time.

A lot of these no tax income millionaires probably also own shares in their own small businesses that can be structured to pay franked dividends and can also use instant company tax write-downs, which were common during the pandemic stimulus package days.

Generous tax rules are controversial

Obviously, a lot of people would like to change these rules, seeing them as tax rorts that mainly benefit the rich but, so far, moving to crack down on policies like the capital gains tax discount and negative gearing have not gathered a lot of political capital to match the outrage.

Perhaps the greatest but arguably least popular strategy to match these income millionaires is to get old.

Getting old can slash your tax bill

Once you enter into the age of 60 to 65, income tax can start to fall dramatically given that superannuation assets of up to $1.7 million can be used to pay a pension that is entirely free of income tax.

So, for example, if you are aged 65 and are getting a pension from $1.7 million in super, you could be earning an income of $68,000 a year or much more if you decide to exceed the minimum drawdown level, entirely tax-free.

Top that up with fully franked dividends from shares and you can quickly build up a very sizeable annual income with no tax payable.

Indeed, at any age if you had around $25 million invested in shares paying out a 4% fully franked dividend, you could be earning $1 million of income a year with a serious tax credit for the company tax paid.

For those with more modest investments and aims – which is almost all of us – the same idea can be scaled down with the added benefit that once you are retired, those franking credits for company tax paid will actually become an income source every year when you do your tax return.

In summary, the three most applicable approaches to legally reducing tax that can be used by people on even quite modest incomes are maximising super, holding shares that pay franked dividends and using loans (gearing) on investments.

Paying tax deductible charitable donations also works in lowering tax but is probably less of an option for those on lower incomes.