Certain taxpayers that have inconsistent levels of income may qualify for income averaging. Australian tax legislation recognises that when income fluctuates drastically from year to year, it may cause hardship or a tax disadvantage. There is a special consideration available that allows a reduction in unreasonable tax rates that may apply in a high-income year, in effect levelling out income spikes.
This special allowance is an adjusted tax rate that applies a four year rolling average taxable income. This concession is only available to specific industries and income earners designated as “Special Professionals”, these include:
- sportspeople
- authors (literary, dramatic, musical, artists, in some cases computer programmers)
- inventors
- performing artists
- production associates (those who provide assistance to performing artists)
The tax law recognises that people in these professions may spend several years on one project but only realise the income at some point in the future. For example, a screenwriter or film producer may spend years developing and producing the work, but will only receive payment after the film is released. For some sportspeople, they are only allowed to compete in their category on occasional bases, such as the Olympics every four years or a tournament. In each of these cases, the income that is earned over several years is characterised by peaks and troughs.
For the special professional income tax, it only refers to the income actually derived from the special category of the professional activity. For instance, if an artist sells a painting, that income could be included, but if they teach art classes, that income would not qualify.
When the income averaging provisions are utilised, the benefits will be most advantageous in the first few years of the special rate. There will be significant tax savings at first, and then it will level off over time as the average rate is applied. The intent of the legislation is to make an “average” fair tax for those that qualify, but remember that all other regular income is taxed at the normal rates.
There are other stipulations that apply as well to the special professional income averaging to take effect. The individual must:
- earn income from one of the “Special Professional” categories (listed above)
- be an Australian resident at any time during the year, and
- satisfy the first year requirement in either the current income year or a previous income year
The assessable income can come from a number of sources, they include:
- rewards and prizes
- endorsements, promotional activities, interviews, advertisements, commentating
- assigning copyright, granting a license for a literary, dramatic, musical or artistic work
- assigning a patent or the right to apply for a patent or granting a license for an invention
- providing professional services
- other assessable income from a literary, dramatic, musical or artistic work, from a copyright or an invention
To calculate the “taxable professional income” you can apply the simple formula as written in the legislation:
Apportionable deductions x (assessable professional income ÷ {taxable income + apportionable deductions})
In general, to reduce the assessable professional income by deductions relating to it and the relevant part of any apportionable deductions, such as donations.
The first year in which a taxpayer becomes eligible for income average is when their taxable professional income is more than $2500 in that year. This becomes year number one in the four-year rolling period that the income is then averaged.
During that four-year period, the Tax Office deems the average taxable professional income (TPI) to be:
- Year 2: one-third of the TPI in year 1
- Year 3: one-quarter of the sum of the TPI of years 1 and 2, and
- Year 4: one-quarter of the sum of TPI of years 1, 2, and 3
In the following years, the taxable average professional income is based simply on the rolling four-year averages. (The total of the four years is divided by 4)
There are specific income categories that are excluded from assessable professional income, they include:
- Superannuation lump sums or an employment termination payment
- Payments for unused annual leave or long service leave on retirement or termination, and
- any net capital gain
During those years of higher or peak income, the tax law provides a special formula to calculate tax payable on the “above average” income - the amount that exceeds the average taxable professional income. The tax on the top 80% of the above average special professional income is 4 times the tax on the bottom 20%.
There may be other factors that affect income averaging for special professionals as well. The tax laws are specific and it can be confusing when trying to calculate the benefits. Not only does the tax office scrutinise this averaging, they are very careful to qualify the income and the professional categories and activities. They will also make sure that other regular income is taxed accordingly. It is essential that you seek professional tax advice from this office if you believe you can benefit from income averaging.
Disclaimer:
Hillyer Riches Management Pty Ltd is a Corporate Authorised Representative (No 466483) of Capstone Financial Planning Pty Ltd. ABN 24 093 733 969. AFSL / ACL No. 223135.This document contains general advice only and is not personal financial or investment advice. Also, changes in legislation may occur frequently. We recommend that our formal advice is obtained before acting on the basis of this information.
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