Income Averaging
Income Averaging - we know you are not ‘average’ by any means, but the ATO have a special rule for people with special income that might help smooth things out in the long run.
Income Averaging is a type of tax relief that the ATO offers to ‘primary producers’ and ‘special professionals’. The common denominator between these two is their fluctuating yearly income. Through Income Averaging, the ATO allows them to even out their income and tax payable over a rolling 5 year period.
Before we get into how it works, first let’s see if you are eligible.
Most of the clients we work with are not primary producers. But, some are special professionals (note: you are all special to me even if you don’t fit the criteria below!).
Are you a ‘Special Professional’?
If you are one of the following it means you are a special professional and could be eligible for Income Averaging.
- Author or inventor - these are general terms for someone that creates musical and artistic work (e.g. sculptors, painters, writers, and music composer)
- Performing artist - you perform with your personal skills in the presence of an audience or appear on television, film, or radio broadcast (e.g. actor (movie or theater), acrobats, circus performers, dancer, and singer)
- Production associates - those who use their artistic skills/with artistic contribution in the production. The examples provided by the ATO are the following (Australian Taxation Office 2022):
- an art director
- a choreographer
- a costume designer
- a director
- a director of photography
- a film editor
- a lighting designer
- a musical director
- a producer
- a production designer
- a set designer
- Sportsperson - someone who uses his physical strength and stamina as an athlete and competes in sport activities.
If yes, read on…
Are you eligible for Income Averaging?
Now that we have identified that you ARE considered as a Special Professional, the next step is to check if you are eligible for this concessional tax treatment according to the ATO’s requirements below (Australian Taxation Office 2022):
- You are an individual who is an Australian resident at any time during the income year
- You are a special professional (see above), and
- You satisfy the first-year requirements (see below) in either the current income year or an earlier income year.
- The first year you are eligible for special professional income averaging is the first income year for which the taxable professional income (TPI) you earned as a resident special professional individual is more than $2,500. This is known as year 1.
If you are eligible, then we need to figure out what income to include in the calculations. Often times our clients have 2 or more jobs and not all of that income should be included in the income averaging calculations.
What are the types of income that will be included in Income Averaging computation?
- Assessable professional income = your income from being a special professional. These include rewards, prizes, royalties, patents, and commissions.
For example, let’s say your assessable professional income is: $50,000 - Taxable professional income (TPI) = Assessable professional income less expenses (directly related to being a Special Professional)
$50,000
(-) $10,000 of expenses
= $40,000 TPI - Average taxable professional income = one-quarter of the sum of your Taxable professional income for each of the preceding 4 years
$40,000 this year + $30,000 last year + $35,000 year before + $42,000 year before that
= $147,000
/ 4
= $36,750 - Above-average special professional income = if your current year TPI is higher than your average TPI, the difference between the two is your Above-average special professional income.
$40,000 TPI this year > $36,750 average
= $3,250 ‘above-average special professional income’
If you have an Above-average special professional income, your tax payable would be computed based on this plus the tax amount on your other income.
How does it work?
Here’s the good thing, you don’t need to figure out your average taxable professional income all by yourself. If you are part of The Real Thiel community, we can help you assess if income averaging will work for you, and the systems we use will handle most of the calculations.
But to give you an idea, your average taxable professional income is computed as follows (Australian Taxation Office 2022):
*TPI - taxable professional income (i.e. the bit you get taxed on)
- year 1 = nil
- year 2 = one-third of TPl in year 1
- year 3 = one-quarter of the sum of your TPI in years 1 and 2
- year 4 = one-quarter of the sum of your TPl in years 1, 2 and 3.
When your average income is less than your taxable income (excluding capital gains), you receive an averaging tax offset.
When your average income is more than your taxable income (excluding any capital gains), you must pay extra income tax. This is included in the tax assessed.
NOTE: we do find when doing this that the first year it is ‘turned on’ there can be a bit of a sugar rush (big refund) but this is not something to get used to because the whole idea is that you ultimately pay the same tax over the long term, but that the tax bills are averaged out or smoothed out over the years so they are easier to manage.
Now that we have an idea regarding income averaging, let’s apply it with another more detailed example below.
EXAMPLE
Mr. Lee, a script writer as an employee and a sole trader, is considered a Special Professional. He has an assessable professional income of $236,559 and other income of $40,000. His total expenses directly related to him being a Special Professional is $32,464. His average TPI over the last 4 years is $10,000.
Mr. Lee’s tax payable, before the Medicare levy or tax offsets, is computed as follows:
Assessable professional income: $236,55 (provided)
Taxable professional income (TPI):
Assessable Professional income | $236, 559
Less: Deductions | $32,464
Taxable professional income (TPI) | $204,095
Average taxable professional income: $10,000 (provided)
Above-average special professional income:
Taxable professional income (TPI) | $204,095
Less: Average taxable professional income | $ 10,000
Above-average special professional income | $194,095
/5 this is... | $ 38,819
(we use this later)
Other income:
Other income | $ 40,000
Add: Average taxable professional income | $ 10,000
Total other income | $ 50,000
Tax on other income at ordinary rates | $ 6,717
Tax on other income plus one-fifth of above-average special professional income:
Total other income | $ 50,000
Add: 1/5 of Above-average
special professional income (from above) | $ 38,819
Total | $ 88,819
Total tax on other income plus 1/5 of above
average special professional income | $ 19,333
Tax on above-average special professional income:
Total tax on other income plus one-fifth of
above-average special professional income | $ 19,333
Less: Tax on other income at ordinary rates | $ 6,717
Multiply by 5 | x 5
Total tax on above-average
special professional income | $ 63,080.90
Tax payable:
Tax on other at ordinary rates | $ 6,717
Add: Tax on above-average
special professional income | $ 63,080.90
Tax payable | $ 69,797.90
Tax rates: https://www.ato.gov.au/tax-rates-and-codes/tax-rates-australian-residents
It is certainly one of the more complicated areas of tax and not a lot of accountants will deal with special professionals because of this. We do though! If you think you might be interested in Income Averaging then reach out.
References
ATO : Income averaging special professionals tax payable
ATO: Income averaging tax returns
ATO: Tax averaging | Primary Producers
ATO: Who is a primary producer
ATO: Concessions for primary producers
ATO Income Averaging for special professionals
ATO: Special professionals Sportsperson
