Tax 102

In the last post we looked at tax basics. In this post we'll look in more detail at how the tax calculation works with some examples, get to grips with tax terminology and some more information about the various deductions and types of tax. This post may be a bit long - I hope you won't find it too taxing!

Tangled up in terminology 

It's easy to get tangled up in terminology and abbreviations. Hopefully the list below will help!
Photo credit: Gavin Schaefer (CC-BY 2.0)

• CGT - Capital Gains Tax. This is a fairly benign tax (relatively speaking) on profits made on the sale of certain assets.
• IRP5 - this is the document issued to you by an employer that pays tax over to SARS in the form of PAYE.
• IT3a - a document issued to you by an employer that does not pay tax over to SARS in the form of PAYE.
• IT3b - a document issued by financial service providers (banks, investment management firms etc.) where the total interest and dividends that you have received is reflected.
• IT3c - a document issued by financial service providers indicating everything you will need to calculate your capital gains (base costs of shares / unit trusts etc. sold as well as their selling price).
• ITA34 - the actual tax assessment issued by SARS. This comes as an annoying pdf that seems impossible to open in anything other than Adobe Reader.
• ITR12 - this is the tax return that you will complete as an individual.
• PAYE - Pay As You Earn: tax paid over to SARS by your employer on a monthly basis.
• SARS - the South African Revenue Services (aka, "the tax man").
• UIF - Unimployment Insurance Fund. A deduction of 1% of your gross income is paid over to SARS and this is matched by your employer.

These documents should be sent to you by your financial people by email - you can always request them if you haven't received them. You need to save them somewhere sensible because you could be asked to send them in. This is called being audited and it isn't scary: as long as you are well prepared.

Retirement deductions

Pensions

If you have an employer pension, then your employer can contribute up to 20% of your income (from this employer) towards your pension and you can contribute and deduct up to 7,5% of your retirement funding income (income received from an employer through which you have a pension) from your taxable income.

Retirement annuities

You can deduct up to 15% of non-retirement funding income (income received from all sources other an employer through whom you have a pension) from your taxable income if you contribute to a retirement annuity.

Let's look at an example to see what this looks like for someone who earns R200 000 gross salary from their employer as well as R100 000 of additional income from other sources:

The maximum amount that they will be allowed from both pension fund contributions and retirement annuity fund contributions is R15 000 provided they contribute at least these amounts. In addition, the employer could be contributing up to 20% (although they're more likely to be contributing something more in line with the 7,5% that you can contribute).

Rules relating to retirement products will be changing soon, but not for the 2015 or 2016 tax years. Possibly (hopefully!) for the 2016/2017 tax year. When these new rules kick in, it's likely that you will be able to deduct 27,5% of your taxable income through your contributions to pension funds, retirement annuities and provident funds.

Donations

As mentioned in a previous post on giving, you are able to deduct up to 10% of your taxable income if you make donations to certain public benefit organisations. You will need to get a certificate from them for all donations made in a given tax year. 

Capital Gains Tax

I'm not going to go into all the details here as Capital Gains Tax can get fairly complicated, so I'll just stick to the basics which cover most situations. I'll refer to buying and selling shares as an example, but this also applies to unit trusts, ETFs or even property investments.

• Each year you can get R30 000 of profit related to the sale of an asset tax free. In other words, when you sell shares, they need to have increased by more than R30 000 in value before you would start paying tax on them. This amount increases to R300 000 in the year of death which is fair as many assets will need to be sold at this stage.
• Once you've deducted the allowed annual exclusion you multiply your profit by the inclusion rate for individuals, which is 33.3% at the moment. So effectively, only one-third of your profits above R30 000 form part of your taxable income. This still needs to be multiplied by the tax rate associated with your tax bracket to work out the tax you would pay on these capital gains.
• When you sell your primary residence, the first R2 million in profit is exempt from capital gains. 
• If you trade shares frequently, then SARS will class you as a trader and any profit you make will be classed as part of your income - this would mean no reduction through the R30 000 exclusion or only including 33.3% through the inclusion rate. All profit will form part of your taxable income in this case. As far as I am aware you need to hold onto shares for at least six months in order not to be seen as a trader.

Here's what the capital gains tax calculation looks like: 

Let's look at an example. Let's say you sell R200 000 worth of shares that you originally purchased for R120 000. Let's further assume that you're sitting in the 25% tax bracket before the capital gains tax is factored in and that all of the taxable portion lies in this bracket.

For more on capital gains tax, here's the comprehensive guide prepared by SARS.

Medical tax credits

If you belong to a medical aid, then from your calculated tax obligation you can subtract R257 for yourself, and your first dependent and R172 for each additional dependent per month that you belong to the medical aid in a given tax year. So for a family of four, the person who pays for the medical aid could deduct 12 X (R257 + R257 + R172 + R172) = R10 296 for the 2015 tax year. This is not a deduction (it's not reducing taxable income); it's a tax credit. So it takes place right near the end of the tax calculation at the same time that you are credited with any tax already paid in the form of PAYE or provisional tax.

Medical costs that your medical aid does not cover can potentially also reduce your tax obligation, but these uncovered medical costs need to be quite big relative to your income to even make a small difference. Nevertheless, keep a record of all uncovered medical expenses and enter the total into the appropriate place in your tax return. Taking photographs of all receipts and storing them digitally is probably the best approach.

For more information see Medical scheme fees tax credit (SARS) and Claiming medical expenses (SARS).

Tax free savings accounts

These were introduced for the first time in the 2015/2016 tax year (the tax year that we are currently in and not the tax year for which we are about to start submitting our tax returns). So there is still time to get one of these, but knowing exactly where to get it and what you should include in it will take some research - this will be the subject of a future post.

Play by the rules

You are allowed to structure your investments in a tax efficient manner. This might influence decisions about:

• When you sell an asset (in which tax year) or how much of an asset you sell.
• How you structure donations (how much, who in a couple does the donating: hint, it's the person in the higher tax bracket!)
• If you're part of a couple, how you might choose who takes on additional work.
• If additional work is even worth it (if most of it sits in a higher tax bracket then it become less worth it; this is where knowing your marginal rate is helpful)

However, tax evasion is not cool and is not legal. Everything you submit must be an honest and accurate reflection of your various income streams. Know the rules so that you can play the game well within the rules.

If  you follow this link you'll come across a spreadsheet that you can copy and adapt to perform your own tax calculations. Some notes on using this spreadsheet:

1. It's designed for someone who knows the very basics of working in Excel.
2. I tried to make it as general as possible, but it is impossible to take everyone's possible tax situation into account. You may need to adapt it in some or all of the following ways:
• Take your age into account when it comes to the rebates and the exemption on interest earned.
• Work out your tax bracket for a given tax year when working out your "tax obligation for the year".
• Add more rows if you have more sources of income not listed.
• Remove the rows associated with retirement funding income and pension fund deductions of you are self employed or your employer does not offer a pension.
3. There may be some small discrepancies between your tax assessment as issued by SARS (the ITA34) and the result from this spreadsheet - if it differs by a few cents it's because you only enter whole number amounts in your tax return.
4. I'm only human - there may be some mistakes here. Let me know if you find them and I'll correct them - I'll update the tax calculator as any discrepancies arise.

Until next time, and good luck with e-filing tomorrow! (Yes, I'm assuming you'll do it the day it opens, not the day it's due! If you qualify for a tax refund you want to use it as fuel for your Financial Independence Engine as soon as possible!)

The Grace of Giving: Now or Later?

John Wesley famously said, “Earn all you can, give all you can, save all you can”. Most of us will admit that generous giving is an admirable quality. How does this fit in with the quest for financial independence?

Now or Later?

As always, there are several sides to the argument...
Photo credit: Kristofher Muñoz (CC-BY 2.0)

At the moment, as an example, we live on roughly 22% of our joint salaries (post tax). Surely that leaves 78% to donate to charities and organisations that desperately need financial support? John Wesley also said “Do you not know that God entrusted you with that money (all above what buys necessities for your families) to feed the hungry, to clothe the naked, to help the stranger, the widow, the fatherless; and, indeed, as far as it will go, to relieve the wants of all mankind?" Whether or not you believe in God, the needs in this country are so enormous that it is difficult to sanction holding on to resources which could serve others. 

On the other hand, if we are particularly good stewards of our wealth, then surely it is better for us to take good care of it, ensuring optimal growth, and allowing much greater generosity in the future - putting compound interest to work for charity, as it were. The hope is that after reaching financial independence, our ability to be lavish with our giving will be much larger. Besides, if we don't save at all, we ourselves will be a burden on society at some point in the future when we are no longer able to work. 

And if we can imagine a third, less altruistic hand in this argument, what about the whole point of this blog? Aren't we supposed to be saving everything we possibly can so that we can reach financial independence as quickly as possible? That couple of thousand rand that you give away each month could be powering the financial independence engine and shaving months if not years off your working life. 

Since this one is probably a bit easier to answer, let's put it to rest now:

Reasons to Give Now:

1. Gratitude. Giving really is a grace. It gives me a chance to reflect on everything we've been given. How wonderful that we are in a position to have so much more than we need that we can give money away! How wonderful that we are able to touch the lives of others, even in a small way. How wonderful that we are able to encourage and support causes that we believe in.
2. There are an awful lot of needs right now. Telling the NGO to let the children in the orphanage hang on a few years for their supper because we're just letting their donation grow by compound interest... you can imagine how well that wouldn't go down. The church roof might actually fall in by the time we are good and ready to start giving. 
3. Good habits die hard. Even if you are giving less than you plan to give in the long run, it means it won't come as such a shock when you finally reach the point where you want to start giving a significantly. The danger of course is that we get so attached to our money that by the time we were going to start, it's just too much... or we haven't taken account of it in our FI calculations, or, or, or... Far better to put the habits into place from the beginning, even if it burns a little bit.
4. Tax. You won't ever make money by giving but if you're giving to the right types of organisations (section 18A) then the government will give you a tax rebate on some of your donations. Up to 10% of your taxable income can be deducted from your taxable income via donations. So you pay a bit less tax. (Mr Cent(ri)frugal will do a more detailed post on this later - this is called delegation.) What is comes down to as far as I'm concerned is you're forcing the government to donate money to the charity of your choice. I like. 
5. Giving in other ways. This doesn't really belong on this list, but it is still something to consider. Sometimes, we can (and should) be giving acts of service, not only money. This costs nothing but time, but can be hugely valuable. Does the organisation you're supporting need volunteers? Maybe this is a way that you can maximise both giving and saving. (I still don't think financial giving should be off the table, though...)

How much then?

Not whether there should be a gift, but what size the gift should be.
Photo credit: FutUndBeidl (CC-BY 2.0)

Okay, so assuming that you agree with me that a certain amount of giving should happen now, the question really comes down to this: where is the balance between the "give all you can" and the "save all you can" clauses of the Wesleyan advice with which I started this post?

I think this is really something each individual or family needs to figure out for themselves. I'll share our thinking, not because I think we've necessarily got this sorted, or because we feel grandly self-righteous about how much we give (as you'll see, we haven't reached our giving goal yet), but because it can be helpful to have a benchmark; somewhere to start your own thinking.

I mentioned that we live on approximately 22% of our post tax income. We donate about 8% of that income to two organisations - one religious, one education NGO. The remaining 70% goes to savings. 

Our end goal is to be giving the same amount that we live on. Wouldn't it be wonderful if we could each support another family to the same standard of living that we enjoy? Of course this money wouldn't go to one other family, but would be spread out across the organizations that we support. It simply gives us an image of how we would like the world to be: every person fully supporting one other person.

We haven't reached this giving goal yet. At the moment, it would just put our financial independence goal too far away. We are (theoretically) only supporting just over one third (8/22) of another couple, living at the same level as we do. But we're working on it. And after financial independence we are confident that this will be possible, if not exactly easy. It forms part of our plan: we are saving more now, aiming for a bigger goal, so that we can make it happen in the future.

In closing, I really do believe that giving, both now and later, is an incredible opportunity. It puts you at the forefront of a different way of seeing the world; a way of seeing the world that isn't about "us" and "them" but only about all of us, together, doing the best we can. Even if we don't get it right straight away, it is a dream that we can all work towards, starting with the smallest donation and building up from there.

To gracious giving, and generosity of heart!
jjdaydream