39% Marginal Tax Rate?

The Labour Party has announced that if re-elected, they would introduce a new marginal tax rate of 39% for an individual’s income over $180,000. The 39% tax rate would only apply to income over $180,000 and the remainder of an individual’s income will be taxed at current marginal tax rates.

Labour believes this change will only affect 2% of the population (who earn more than $180,000) and explain that it will help maintain balance as they continue to manage the impact of Covid-19.

Significant price fluctuations in cryptocurrency may result in significant profits that breach the $180k income thresholding, resulting in paying tax at 39%. Or, a one-off event in one financial year could trigger a large taxable income (such as selling an entire portfolio purchased at a lower price).

How will this new tax affect me?

Most of our cryptocurrency clients are full time salaried employees who earn approx. $120 – $170k pa. This new tax will make no different from their employment perspective and the amount they receive from their salary (because the new top tax rate only applies to income over $180,000).

Generally speaking, these full-time employees also own between $30,000 – $1m+ of cryptocurrency. An increase in price (taxable income) is why an increase in the top tax bracket may affect them.

For example, John is an employee earning $150,000 per year and has $100,000 of cryptocurrency. During the year his cryptocurrency increases in value to $190,000 (and he realises this gains). Therefore, he has taxable income is $240,000.

Using existing tax rates

John’s salary has PAYE deducted from it throughout the year and paid to IRD by his employer. He has $90,000 cryptocurrency profit, which will be taxed at 33% (33% is the current top marginal tax rate for any income above $70,000).

This results in $29,700 of tax to pay.

Using the 39% tax rate for income over $180,000

There are no changes to John’s employment income or PAYE deducted because the amount is under $180,000. Of the $90,000 cryptocurrency income, $30,000 will be taxed at 33% (taking John’s combined income up to $180,000 is taxed at the marginal 33% rate), and $60,000 will be taxed at 39% (for income over $180,000).

This results in $33,300 of tax to pay, an increase of $3,600 for John with Labour’s new tax policy.

What if John’s crypto portfolio was currently $300,000, it increased to $1.5m and he realised the gain?

While this may seem unlikely, based on several conversations with clients lately, this scenario is popular to discuss. We have experienced this type of activity from preparing many clients 2018 financial statements (when BTC increased from ~$3k to ~$30k), and more recently when clients have made significant gains on tokens such as LINK.

Using John’s PAYE salary of $150k as outlined above, combined with the $1.2m cryptocurrency profit, John would have $396k of tax to pay under current tax rates.

With an increase in the top marginal tax rate to 39% for income above $180,000, John would have $469,500 of tax to pay, or an increase of $73,500.

What can you do about this?

Consider the ownership structure of your portfolio:

  • Trust’s pay tax at 33%,
  • Companies pay tax at 28%,
  • Is your portfolio and activity joint with a partner (who may have a lower marginal tax rate)?

Consider the timing and realization of income:

  • If you do not sell cryptocurrency there is no realised gain (or loss) and therefore no taxable income.
  • How do you currently decide when you make a trade? What is your exit point? Is tax considered (especially if the gain is reinvested into a different cryptocurrency token). Are you best to sell at regular intervals and diversify into other coins (which triggers a taxable event each time), or,
  • best to hold long term and delay any tax payments until the gains are realised in the future. Therefore, any potential tax funds remain exposed to market conditions (which may provide a compounding effect compared to [b]).

Important notes

As with any transfer of property, a strong commercial reason is required for doing so – transfers for tax purposes alone suggest a tax avoidance arrangement.

There have been many tax avoidance court cases (especially pre-2009 when the top marginal tax rate was 39% and the trust tax rate was 33%). See Penny and Hooper for more details.

There is a new trust Act commencing from January 2021. This will affect all trusts and result in higher compliance and administration costs, and a higher level of trustee involvement is required than previously (for example, keeping core trust documents, trust minutes etc.). We have outlined further information about the new trust Act here.

Losses in trust and companies are not able to be deducted against employment income; compared to an individual’s own name which if they paid PAYE tax will normally give rise to a tax refund.

A transfer from you to another entity (such as a company or trust) results in a sale in your own name (at market value). This may trigger a realised gain (a taxable event) which needs to be considered along with other commercial reasons.

Contact Us

Contact Tim Doyle for a no obligation call or meeting to discuss any cryptocurrency tax or accounting questions. Our office is in Cambridge, Waikato, or we can arrange a video conference call.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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