How to Prioritise your spending

Personal Income Spending Flowchart

As usual, before reading this post, please read our general advice disclaimer!

If you are like most people, you might be in a quandary on how to prioritise your income. For those who grew up in families that lived paycheck to paycheck, cashflow management was definitely not something taught at home, let alone at school!

When I sit down with my clients and ask them what they are aiming to achieve and what they expect from me, most think about investing in property, shares, super, discretionary trusts and tax planning among other things. While sound investing is an appropriate focus, it should not come at the cost of ignoring essential cash flow management.

For those in survival mode - they simply earn income and pay expenses. The only way to escape this cycle is to earn more and spend less. But earning more and spending less is not enough,  you must also engaged in the process of cash flow management.

Real cash flow management involves the understanding of where your money comes from and where it goes, and examining what choices are appropriate to create a life of greater satisfaction. Cash flow management is an active process.

This infographic is designed to help those people who need help in prioritising their spending. While procrastinating on Reddit a few weeks back, I saw a couple of magnificent posts by /u/beached69 and /u/atlasvoid. Inspired by their work, I created the Australian "How to Prioritise your Income Flow Chart.

Tax Loss Harvesting in Australia

As always, please read the general advice disclaimer before reading this article.

Crystallising a tax loss by selling an asset is not a problem, but what you do after that could be. For example, wash sales (the quick sale and repurchase of the same asset to crystallise a paper loss) are definitely not allowed. Some countries define in very clear terms what constitutes a wash sale. For example, in the United States you cannot claim a capital loss if the same stock is sold and bought back within 30 days.

Australian tax laws are not quite as clear as that. We do not have a specific 30-day buyback rule; instead, the ATO asks us to interpret the less clear 80-year-old general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act (ITAA) 1936.

You will run foul of the Act if you answer yes to both the following questions:

1. Did you obtain a tax benefit from your activity - a benefit that would not have been available if you had not entered into it?

2. Would it be concluded that you entered into the scheme for the sole or dominant purpose of obtaining a tax benefit?

Of course, people love to interpret things to suit themselves and in the absence of specific guidelines this is exactly what they did. Which meant wash sales became very popular. But when too many people start bending the rules the ATO's antennas go up, and in 2008 it issued tax ruling TR 2008/1, which specifically outlawed arrangements where:

"…in substance there is no significant change in the taxpayer's economic exposure to, or interest in, the asset, or where that exposure or interest may be reinstated by the taxpayer".

That's ATO speak for no wash sales. But a specific timeframe was not defined. Just don't do it "within a short period".

Where the ruling did provide clearer definition was in banning the following arrangements:

1. Claiming a tax benefit from selling an asset a short time before buying it back, or buying the same asset a short time before you sell it.
2. Entering into a repurchase agreement with another party (including family members). That is, an agreement to sell it now and buy it back later for a predetermined price.
3. Transfers between yourself and a company or trust in which you have an interest, in order to achieve the same economic benefit.
4. Using derivatives or financial instruments to achieve the same result.

Avoiding penalties

A breach of the Act carries penalties of up to 50 per cent of the tax avoided. Penalties also extend to promoters of these arrangements.

In assessing your activity the ATO will consider your intent. If it can be shown the dominant purpose of your buying and selling was to turn a paper loss into a tax-usable loss, then you are in trouble. This does not cover the simple act of selling and then declaring the loss. Nor do you breach the Act if you buy and sell two different companies within a short time frame, even if they are in a similar line of business. Selling Rio and buying BHP is OK.