Bucket Companies: what you need to know to save $$ in tax

We’ve been talking about tax saving strategies in our office lately – quite a bit actually being tax time and all.

But again this year we face the tax planning mystery  – It’s this feeling that we need to talk in hushed tones, looking over our shoulders as if our desire to save you money is cheating or illegal.

The reality is that there are legitimate and honest ways to lessen your tax burden.

With a little knowledge, creativity and forethought, you can free more of your money to be used for any purpose you choose.

So, why pay more than your fair share in tax?

Today, we’re talking about Bucket Companies – one of the least known and probably most underutilised strategy to save you thousands in tax (no hushed tones today).

What is a bucket company?

A bucket company takes ‘excess’ profits distributed by a trust, after distributing a reasonable amount to the people within a family group.

The idea of a bucket company is to ‘cap’ the tax on profits distributed by a trust to 30% or maybe less – instead of paying top marginal tax rates on the trust distribution to individuals.

Tax savings is the end game.

Who is a bucket company strategy for?

A bucket company strategy works best for business owners or investors, who are running their business or receiving income from a discretionary trust.

A bucket company strategy could save you thousands in tax if:

• You earn more than your cost of living and want to start building a wealth portfolio for your family;
• You have large fluctuations in income between financial years as the bucket company can help you smooth out your tax bills; or
• If you get whacked with the highest marginal tax rate because of trust distributions you receive.

What are the tax benefits of using a bucket company?

When done right, Bucket Companies can save thousands of dollars in tax for a client, year on year.

We’re going to show you how this works with a couple of examples, but first, let’s compare tax rates:

For the 2018 FY, the individual tax rates (incl. Medicare) are:

INCOME THRESHOLD

$0 – $20k

$20k – $37k

$37k – $87k

$87k – $180k

$180k+

TAX RATE

0%

19%

34.5%

39%

49%

Meanwhile, company tax rates for 2018 FY are:

INCOME TYPE

business income up to $10mil revenue

business income over $10mil revenue

investment income

TAX RATE

27.5%

30%

30%

Notice how as personal income increases, so does tax on the dollar earned.

Compare this to a company –  where it only pays 30% on the first dollar it receives, but every dollar after that.

This why we can use a bucket company to “cap” tax on profits distributed by a trust.

What would a bucket company strategy look like?

Let’s look at the benefits of the bucket company using $300k profit as a case study.

So if we’ve got a trust that’s earned $300k in profit, we need to allocate that to people or entities within a family group.

This is what it would look like before we use a bucket company:

So the total tax paid by the group is $92.2k with the net profit being $207.8k.

What happens when we use a bucket strategy?

The magic number from a distribution perspective to individuals from a family group is $87K (trust us on this one). We then distribute the remainder of the trust profit to the “bucket company,” i.e. it’s put in the bucket.

This is what it would look like with the use of a bucket company:

Under this scenario, the total tax paid by the group is $81k with the net profit being $219K.

A tax saving of $11,200!

Now let’s see this again with a trust income of $500k.

A tax saving of $40,400! Not bad… what do you think?

Do you need to actually pay the cash to the Bucket Company?

When we distribute to a company, the cash needs to follow as well. So, yes – the company needs to get paid the amount that was distributed to it.

Otherwise, we raise Division 7A issues, and the ATO doesn’t like ‘on paper’ distributions without the intention of paying them.

How can you get the cash out of the bucket?

So, we just discovered that the cash needs to follow the trust distribution to the company.

All well and good, but now we’re left with money in the company –  how do we get the money out of the bucket?

There’s two ways we can do this:

1. Borrow from the company
2. Pay dividends to the company shareholders

Borrow from the company

With this approach, your bucket effectively becomes your bank.

It lends you money, while you then pay principal and interest repayments back to your bucket.

Loans from your company are called ‘Division 7A loans’ and have quite a few things that need to be considered:

• The ATO sets the interest rate each year, but it’s usually quite fair (around 5 – 7%).
• If your loan is unsecured, you have 7 years to pay back the loan.
• While, if your loan is secured (on a property for example), then you have 30 years to pay it back.

So, it’s like using the bucket as a bank – but skipping all the middle men.

But, Division 7A loans can quickly turn ugly if not treated correctly, so working with an Accountant who knows their stuff is super important.

Food for thought: This strategy can be very effective for loaning your 20% deposit for a property, then the 80% difference from an actual bank.  That way (if secured) you get 30 years to pay back the loan to your own company. (Want to learn more?).

Pay dividends to the company shareholders

The second way to get money out of your bucket is by paying a dividend to the company shareholders.

There are two things we must consider with this approach:

1. When we pay a dividend to a shareholder – the shareholder gets taxed on that dividend, but they receive a ‘franking credit’ for the tax that the company has already paid. So, there are tax impacts that you need to consider.
2. You must seriously think about who the shareholders of the bucket company are going to be.
   If they are individuals, then you can only distribute to those individuals (in the % of shares that each of individual owns). While this works for some, in most it results in little control over what each shareholder can earn separate to the dividend. So, the best thing to do is to create another, separate trust to receive the dividends from the bucket. That way, the new trust has the flexibility to distribute the dividends in the most tax effective way.

So, in summary –  getting the money out isn’t necessarily straightforward – working with an adviser who knows their stuff is non-negotiable.

Do you need a bucket company?

At Cinch, we’ll know after a quick glance at your numbers, whether a bucket company strategy is right for you.

If you want to ask any questions about this strategy or

if you’re paying too much tax and want that to stop – get in touch with our team.

What would you do with the tax savings?