A bucket company is a structure that businesses can use to maximise their profits and to structure their business and personal assets in a tax effective and strategic manner.
The term ‘bucket company’ is used as it sits under your business to ‘catch’ the profits you determine to be not payable to you, thus saving on tax for you and your business.
A bucket company is also what individuals use to pay shareholders dividends in a secure way that protects the wealth accumulated through the businesses hard work.
With so many individuals and families now running their own successful businesses and relying on the income and profits for lifestyle, understanding what a bucket company is and how it can benefit your position is smart business and can only be enhanced by engaging with a financial planner.
A financial planner will look at both your business and personal finances, to see how it can best be structured with a bucket company and many other strategies that enhance both your business earnings and your long-term financial position of you, your family, and your retirement fund.
To see how we implemented this strategy for one of our existing clients, click here.
Explained – What Is A Bucket Company?
A bucket company is set up to be the beneficiary of a trust. In this situation, the trust is often your business that you pay yourself and your bucket company from.
This is done to save on tax, so you don’t end up paying the individual tax rate on all your earnings, rather the money paid to the bucket company is only taxed at the corporate tax rate.
As of 2020-21, the individual tax marginal tax rate is 45% (not including the 2% Medicare levy) and the company tax rate is 27.5% or up to 30% if it is only used for investment purposes.
For example, if your businesses profit was $270,000, you would be taxed at 47.5% on everything above $180K or in this case $90K, making tax payable on this portion of income at $42,750. If instead this money was directed to a bucket company, it would only be taxed at the corporate tax rate of 30% or in this case $27,000.
As you can see, with a bucket company in place and a deliberate structure to what money goes where, based on your needs, you could be saving a total of $15,750 per year in tax.
What Is A Bucket Company and How It Can Be Enhanced With A Financial Planner
As we’ve explored, a bucket company is a tax mechanism and will typically be recommended by Accountants, as it relates to your business and personal tax position.
The reality is however that too few people we see have a strategy that integrates their business structures, with their personal financial plan.
At Yield, we believe that your business and personal strategy should be consistent and cared for with a unified strategy that you, the client, establishes considerate of your goals and desires both in business and life.
Your financial planner will consider important aspects and distinctions of setting up a bucket company, such as how to distribute to a bucket company, considerate of your personal income needs and tax position. This will be done in conjunction with your Accountant.
Once a suitable sum is determined, you must distribute the physical amount of funds into the bank account of the bucket company that you elected before you lodge your tax return.
Alternatively, if you cannot pay this amount by the time you lodge your tax return there can be provision to create a Division 7A Loan.
Division 7A Loan Explained
A Division 7A loan, is often a provision business owners use when their business is growing and their profits are strong, but cash has been reinvested into the growth of the business.
When this is relevant, your Accountant will apply through the ATO on your behalf and this can allow you to pay the loan between yourself as a sole trader, partner, or trust, and the bucket company over seven years, with interest charged at a benchmark rate.
What To Do With The Money In The Bucket Company
Once the funds are in the bucket company the question is what to do with them. One strategy we consider is using the bucket company as a long-term investment vehicle for retirement.
This can be a highly tax effective strategy, as investment earnings are taxed at the company tax rate of 30% and franking credits are accrued on tax paid.
With a well formed strategy, it is possible to draw down on the accumulated balance in retirement, where it is often most tax effective to do so.
If you want to extract money from a bucket company, it can only be done through the elected shareholders of the company, which means that the dividends must be paid to the exact percentage of the shareholder.
If these are being distributed to individuals, this can be fairly restricting in how the dividends are divided.
That is why, to receive the dividends in the most tax effective way possible, it can make sense to set up another trust to hold the shares of the company.
Also, as the dividend has been taxed at the company tax rate, the shareholder receives a franking credit on the tax already paid.
This also benefits the business owner as dividends paid into the company trust adds a level of protection for their assets, in comparison with holding these assets as an individual.
The profit paid into the bucket company is an ideal structure for a long-term investment as the bucket company can invest in shares, properties and any other private investments.
Whilst we have gone into detail of what the possibilities and considerations of what bucket company is and how it can enhance your business earnings, and thus your broader financial outcomes, we have only scratched the surface here.
Yield Financial Planning Is Here To Help
Good fortune needs great planning, so if you have any further questions on if this tax and investment mechanism is right for you and your business, get in contact with one of our financial advisors to discuss your options.