Thursday, January 26, 2012

Traders and tax

Traders are at a distinct advantage over ordinary workers when it comes to income tax. Under Australia's PAYG (pay-as-you-go) tax system, an employer is required to withhold a portion of an ordinary worker's wage as tax during payment.

On the surface, this seems like a fair and user-friendly arrangement. After all, isn't it better to pay a bit of tax every week instead of a giant tax bill at the end of the financial year?

If you are financially responsible, the answer is a resounding no and I will explain why.

Lets compare a trader with an ordinary worker. Both earn $100k before tax.

The ordinary worker pays $25,150 in tax. Under the PAYG tax system, he never gets his hands on $25,150. It automatically comes out of his pay every week. His after-tax income is $74,850.

The trader will likewise pay $25,150 in tax. Unlike the worker however, he will have access to $25,150 until the end of the financial year. That is $25,150 worth of extra capital that he can use for the year.

Professional traders can earn upwards of 10% per month. For simplicity sake, suppose the trader earns a 100% return from the $25,150 for the year. His new pre-tax income is now $125,150. The trader pays additional tax on the $25,150 he has earnt. His final tax obligation is $34,450, leaving him with an after-tax income of $90,700.

$74,850 versus $90,700. Both the trader and the worker pay the same initial tax. But because the trader has full access to pre-tax income that he can utilise, he emerges financially stronger.

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