You don’t need to find a loophole in tax legislation to get a tax refund. In this post, I outline the simple principle to getting a tax refund, discuss a few common situations that result in tax refunds, and outline a method to get your tax refund before you lodge your tax return.
The Principle That Leads to Tax Refunds
Enough suspense, here’s the basic principle:
- During the year, you pay an estimate of your year-end tax bill and/or an estimate is withheld from your wages.
- Your tax return calculates the actual amount of tax to pay.
- If step 1 is higher than step 2, you get a tax refund. Otherwise, you need to pay tax.
There are a few rules of thumb that follow from this simple principle:
- You probably won’t get a tax refund if you didn’t pay tax (or have it withheld from your wages) during the year.
- You may have to pay a lot of tax when your return is lodged, if you didn’t pay enough tax or wage withholdings during the year.
- If you earn an unusually large amount during the year, for example a capital gain on the sale of shares or property, set some of the proceeds aside for your inevitable tax bill! Your tax accountant can calculate the amount, but hopefully you talked to them before the windfall so they can make some suggestions on reducing your tax.
Common Situations That Lead to Tax Refunds
Here is a quick list of the most common situations that lead to tax refunds:
- Withholding too high: Changing from a higher-paying job to a lower-paying job (or the reverse) often results in a tax refund. The reason is that tax is withheld from each wage payment on the assumption that the taxpayer will earn the same amount for the full financial year. In terms of the tax refund principle above, step 1 is increased.
- Negatively-geared investment property: If a property is ‘negatively geared’, this means that the income is less than the expenses, usually due to loan interest or depreciation, and therefore shown as a loss on the rental section of your tax return. This loss indirectly reduces step 2 of the tax refund principle.
- Large work-related deductions: Usually employees who drive a lot for their work, students who work in their field of study, and teachers who spend a lot of money on classroom resources. In both cases, the deductions indirectly lower step 2 of the tax refund principle.
Tax Refunds and Withholding Variations
Instead of receiving a large tax refund at the end of the year, you can receive it throughout the year as higher wage payments.
You can lodge a Withholding Variation form with the Australian Taxation Office and they will send a letter to your employer specifying a lower withholding amount or rate. Therefore, your wage payments will be higher.
A Withholding Variation is most useful for owners of negatively-geared investment properties, to help them pay their property expenses during the year.
The business equivalent of Withholding Variations is varying their income tax instalments.
Be careful though: if your withholdings (step 1 of the principle) are lower than the tax calculated on your next tax return (step 2), you will need to pay tax when your return is lodged (step 3). If there is a large tax payable when your return is lodged, this will affect future withholding variation requests.
This is a simplified overview, but I hope it helps. As with anything tax, it’s best to ask your tax accountant about your specific situation.