When it comes time to pay the tax man, it can leave a bitter taste in most Australians’ mouths, particularly when it comes to capital gains.

Watching all those hard-earned dollars flow into the government’s coffers can be tough, but what if I told you there were two simple ways to eliminate or almost completely reduce the amount of tax you have to pay? And neither are illegal.

Let’s take a closer look.

Doing nothing has never been more profitable

The first thing you can do to pad your bank account is to sit back, relax and let your investments go to work for you over the long term. Holding an investment for less than one year means getting taxed at your top marginal tax rate for your gains. That could see as much as 45 cents and another 2 cents for the Medicare levy in every 100 cents flow into the Australian Tax Office’s coffers.

Simply holding your investments for longer than 12 months means you are only taxed on 50% of the capital gains. And if you want to take the ultra-long holding period until you reach retirement age, then the capital gains could be totally tax-free.

Don’t forget that holding for longer also means compounding has longer to work its magic, meaning more of a bonus for you at the end.

Use superannuation as your preferred investment vehicle

Taxed at 15% on contributions up to the annual limits, superannuation is one of the best tax vehicles to use – as long as you are happy to hold your investments until retirement. Even under the government’s planned changes to cap super at $1.6 million, it still is the best way to invest for retirement as we wrote in early May.

Most investors will struggle to save $1.6 million in super, while for those investors who have managed to accumulate more than that will still only be taxed at 15% on the income earnt on the amount over $1.6 million.

Bonus Tip: Invest in shares paying fully-franked dividends

If you invest in the share market, make sure you have some invested in shares that pay fully-franked dividends. It means that the companies have already paid tax on the dividends – so you don’t have to. Some companies paying fully franked dividends include Telstra Corporation Ltd (ASX: TLS), TPG Telecom Ltd (ASX: TPM), the big four banks and Seek Limited (ASX: SEK) to name just a few.

Foolish takeaway

Being smart about how you invest and where you invest can save you thousands of dollars, and if you let the power of compounding do its job, you should be headed for a very comfortable retirement.

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Motley Fool writer/analyst Mike King owns shares in Telstra, TPG Telecom and Seek. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.