09 Nov 2017

Doctors – 4 Income splitting scenarios that may help minimise tax

Are you a doctor or allied health professional looking for opportunities to save tax? Have you considered the benefits of income splitting?

Regulations for income splitting are clearly laid out by the ATO and it’s obviously important to follow them closely. Let’s start by understanding a little more about the benefits and risks associated with income splitting.

What is income splitting?

Income splitting refers to arrangements where income is diverted from a taxpayer who is taxed at a higher marginal rate to a taxpayer taxed at a lower marginal rate – or not taxed at all.

Different types of entities may be used, and they all offer both advantages and disadvantages.

Professional practices can be operated using structures including sole trader, partnership, company and trust from the Australian Taxation Office’s perspective. However, you would also need to meet the requirement of your professional body.

It is vital that income splitting is done legally, within the framework allowed by the ATO so that audit risk is avoided.

Diverting income in this way may include practices that the ATO can determine as “tax avoidance” so getting it right is very important.

It’s best explained using some possible scenarios…

4 income-splitting scenarios for doctors to consider

Consider the following four scenarios and the associated benefits and risks:

  1. Paying a wage to a spouse or family member on a lower tax rate to reduce your tax liability: this can be a risk if you receive all of your income from one source and don’t satisfy the personal services income tests. If you satisfy the personal services business rules, then you are allowed to pay wages to family members for administration and bookkeeping type work. The amount you pay needs to be reasonable. How much would you pay someone else to do that work?
  2. Operating your professional practice through a partnership structure with your spouse and sharing profits with your spouse who is on a lower marginal tax rate – this can be a high audit risk. It is acceptable if both of the partners are professional practitioners but the ATO has strict guidelines for professional practitioners that need to be met.
  3. Operating your business through a company structure and paying tax at the lower company tax rates – this is acceptable in very limited circumstances. However, the general rule for professional practitioners is that the profit of the company needs to be paid out as wages to the practitioner on an annual basis.
  4. Using a discretionary trust – this is a common practice for professional practitioners to minimise tax by distributing income to lower-taxed family members. However, it is a complex area of tax law and the ATO have strict guidelines to deal with this.

Where a practice involves principal practitioners and non-principal practitioners, then the principal practitioners need to satisfy one of the following arrangements to be considered a low risk of audit:

  • The professional practitioner receives an appropriate income for the work performed. An appropriate income can be determined by looking at other professionals employed in the practice or comparing relevant industry benchmarks.
  • The professional practitioner is assessed on 50% or more of the income from their practice and associated entities.
  • The professional practitioner and all their associated entities have an effective tax rate of 30% or higher on the income received from the practice.

If you are unable to satisfy one of the above tests, then you would be classified as high risk and potentially be subject to an ATO audit.

Are you a doctor considering income splitting and in need of some advice? Please call me on 02 4322 9044 for a chat.