Income averaging: The concessional tax treatment every creative should understand
Don’t feel left out if you haven’t heard of this before. This is a very specialised aspect of tax. In fact, your accountant (unless they specialise in creative industries, like us!) might not even know about it. And if you regularly prepare your tax returns yourself it’s unlikely to be on your radar.
So what’s the deal?
It’s very likely that, in a creative profession, your income varies greatly year on year. That means that your tax also varies year on year.
When you earn more, you pay more tax.
Because of this, people with highly variable incomes might be disadvantaged by the way our tax system works.
Special Professional income averaging (income averaging) helps to even out the peaks and troughs in income (for tax purposes) to reduce tax disadvantage.
So if you’re a professional creative, this could mean better tax refunds if you use this concession.
How does it work?
Income averaging isolates your Special Professional income from creative sources and taxes it at a concessional rate, based on your rolling 5 year average.
This means that you pay less income tax in years where your income from these sources is significantly above average.
In years where your income is below, or in line with your average, your income is taxed at normal marginal tax rates.
Irrespective of income averaging, income that you receive from other sources is always taxed at normal rates.
You may not receive any benefit from averaging in years where your income is below average. But, you will receive the benefit in future periods. Years of lower income will affect your ‘average income’ in subsequent years, and reduce your tax rate for the years where you earn above average income.
In its most basic form:
- Your average income is calculated by isolating your Special Professional Income (eligible income from creative sources) for the current and previous four financial years.
- Where your current year Special Professional Income is above average, that portion of your income will be taxed at a concessional rate, reducing your income tax payable for the period, and increasing any refund you may be entitled to.
- If your income is below the average, you will be taxed at the normal marginal tax rates, with the benefit of the reduced rolling average to be applied in future periods.
Who is eligible?
A Special Professional is “an author of a literary, dramatic, musical or artistic work, an inventor, a performing artist, a production associate or a sportsperson.”
Broadly, as a ‘production associate’ you’re considered to be a Special Professional if you’re in a “creative decision making role”. That is, if you use artistic rather than technical skills in a production.
This means there are exceptions. For example, a Director may be eligible but some Assistant Directors may not. Eligibility is considered on a case-by-case basis, so it’s always worth getting advice from a tax professional to see if you qualify.
These jobs are included because of the inconsistent nature of income. For example, as a screenwriter you might spend years developing a project, and not recieve income until the very end.
Year on year, you’ll have huge peaks and troughs, and owe much more tax at the end of the process, than during any other year. But If we could spread the income over the whole development process, the amount of tax you owe will be much lower overall.
Your project is a long-term game – you get the pay-off at the end. This tax concession is similar in that it provides it’s greatest advantages when considered over time, rather than year on year.
It is important to note that you can be classified as a Special Professional as both an employee and a sole trader. However if you trade through a company or trust that you have control over – income you receive via that entity, either as wages, contractors fees, dividends or distributions, is ineligible for averaging.
To justify your role as a Special Professional you will need to be able to show proof that you fit the above criteria. You might provide,
- Contracts, position descriptions, or letters of offer specifying your job role.
- Copies of your invoices specifying services provided.
- Evidence that your LinkedIn and social media accounts accurately reflect your income earning activities.
When to start
You can start using Special Professional income averaging when you have earnt more than $2,500 from creative work. But most people are a little deeper in the creative game than that when they first get started with income averaging.
Remember, income averaging only uses income generated from creative activities to calculate your average. That means other income, like what you earn from non-creative activities, interest or investments, is not considered toward your average.
We have the option of including you in the system from your next income tax return or, depending on your specific circumstances, we can go back and adjust your previous income tax returns to claim the concession from an earlier period.
It is an opt-in system, and once you have opted in, you remain in the income averaging system.
What to consider
Many clients see substantial benefits in the first few years of averaging, due to their initial average including zero income for the years immediately preceding entering the system.
The results become less pronounced as your average income normalises. This is important to remember because, as it is an opt-in system, you cannot opt-out when your income normalises.
And remember, the income averaging concession only applies in ‘good’ years. You are not taxed more in years you earn less.
As a general rule, you will never pay more tax due to income averaging.
As we’ve said, this is a specialist field of tax. We are well versed in Special Professional income averaging, and can help you understand whether or not it might be beneficial to you. As we work together, where others might charge a commission based on a percentage of your tax return, we charge a set yearly fee. This makes it predictable and manageable, so you get the most from your return.
If you want to talk about any aspect of your personal taxes, including Special Professional income averaging, book a free consult with us today.
A note on this article
Information provided by Above the Line Accounting on this website is general in nature and does not take into consideration your personal financial situation. It is for educational purposes only and does not constitute formal financial advice.