Franked dividends can complicate your tax return
ANYBODY considering investing should be aware of the way the franked dividend system affects the after tax return.
Suppose you received a dividend of $700 - if it was fully franked it may carry franking credits worth $300.
Thanks to imputation you are entitled to use those credits to pay your own tax with. In other words they are as good as cash, as you can even claim a refund of the credits if all your tax is paid. As the credits represent value, you have to pay tax on them. Consequently, even though you received only $700, you have to declare $1000 ($700 + $300) as taxable income. That's the bad part - now comes the good bit.
If the shares were held by your superannuation fund, and that fund was in accumulation mode, it would be paying a flat rate of tax of 15%. The tax on $1000 is $150, but you have the whole credit of $300 available. In other words, $150 goes to pay your tax on that dividend, and the $150 left over can be used to pay tax on other income or even to reduce the entry tax on deductible contributions.
If you earn between $37,000 and $80,000 the tax payable on that $700 dividend would be $325 less $300 in credits - your franked dividends are almost tax free. If you earn over $180,000, the top bracket, the effective tax on franked dividends is still just 23.25%.
Let's sum it up. For lower income earners franked dividends are tax free and give an extra bonus because they reduce tax from other sources. For most income earners the tax is tiny. Whichever way you look at it, it sure beats paying your full marginal rate of tax on bank interest.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: email@example.com.