How to Make Australian Income Tax Efficient
Tax was my highest expense in 2019/2020 – four times the cost of my next largest expense (housing).
If you’re paying tax, you’re earning income. If you’re paying lots of tax, you’re earning plenty of dough, so have no reason to complain!
But not all income is equal to the tax office.
Tax avoidance is illegal, and will land you in serious hot water! Definitely not worth taking any risks. But the Australian Tax office (ATO) allows tax optimisation. A small reduction in your tax bill can make a significant difference to your take home pay.
We will discuss some of the ways to make sure you are paying only the tax you are obliged to in this article, starting with the big power moves, and moving on to the easier, small but important optimisations.
Consider More Tax Efficient Income
As your income increases in Australia, the tax efficiency declines substantially due to the “Progressive tax” system (the more you are paid, the higher % of your income you pay in tax).
Tax on this income “Marginal Rate”
Net income for maximum in bracket
0 – $18,200
$18,201 – $37,000
19c for each $1
$37,001 – $90,000
32.5c for each $1
$90,001 – $180,000
37c for each $1
$180,001 and over
45c for each $1
Table from ATO website
Investment income is also taxed at your “Marginal rate”, but Capital gains are discounted by 50% if the asset (e.g. property or shares) is sold after at least a single year of ownership. If you made all your income in a year from capital gains, you would halve your tax rate!
In contrast. Business income is taxed at a flat rate of 30% with small businesses (up to $50 million annual turnover) currently taxed at 27.5%, reducing to 25% for 2021/2022.
If your business income is produced more than 50% from your personal work /skills (Most GP or private specialist practices) it is classed as “Personal Services Income” and taxed at your marginal rate (completely losing out on the advantageous taxing of businesses).
Business income has to be a genuine business, at least 20% needs to come from business income rather than passive investments (some would open a “Company” to keep assets under and pay tax on rent/dividends on business rates rather than marginal rate).
Once you earn above $37000 annually (32.5% marginal tax), income is more efficiently earned through business (25-27%) or capital gains (Up to 22.5%).
You are actually penalised by earning income through personal effort!
It’s definitely worth investing outside your career in medicine and start creating income taxed more advantageously.
Salary Sacrifice to Pay 15% tax Instead of your Marginal Rate
Salary sacrificing your accommodation costs is as close to a no brainer, easy tactic to reduce tax paid for those whose employer offers this great perk. Cut through the confusion with my article on salary sacrifice for doctors here.
Utilise Your Partner’s Marginal Rate
Single income families are disadvantaged by the tax system. A couple each earning $150,000 would pay 32.7% of total gross pay in tax. A single earner bringing in the same household income of $300,000 will pay 41.2% in tax.
Having a stay at home partner/parent is far from a purely financial decision, and the Aussie Doc household have chosen to make this choice, despite the tax disadvantages.
The one advantage of having a non-earning partner is their marginal tax rate – 0%. That’s the best you can get! Your stay at home partner can earn up to $18,200 per year in investment income without paying tax. That’s better than superannuation!
Remember, to think in to the future – if your partner returns to work will it still be advantageous to have the investments in their name? Selling the investments will result in paying capital gains tax (hopefully with 50% discount if held for more than a year).
Keeping Lifestyle Expenses within a Lower Tax Bracket
There is an argument for purposely keeping annual spending under the next tax bracket (minus tax), and using the excess income to fund tax advantaged investments, or to allow part-time work.
Pay / grade
Total tax as % of gross income
14297 + 1400 medicare levy
RMO ~ $90k
20797 + 1800 medicare levy
Registrar ~ $150k
42997+3000 medicare levy+875 MLS
Specialist ~ $300k
108097+6000 Medicare levy+ 1759 MLS
From the table above, if the $300,000 specialist cut down to 0.5FTE their tax % would reduce from 41.2% to 32.7%. Instead of receiving $82.80/hr after tax on average, he/she would receive $97.10 net per hour worked.
Not everyone would want to work part-time of course, but the choice to do so is limited by costs of annual living expenses.
The specialist would have to keep their annual spending under $100,991. How much a doctor allows lifestyle inflation to absorb his / her pay is the main barrier to having this choice.
I almost didn’t include this for fear of encouraging you to invest to save tax.
Investments should be made for their anticipated (well researched) returns.
Many, many doctors before you have fallen foul of making investments to save tax -and lost a lot of money in the process. If the underlying asset does not perform, you are literally throwing money away!
But if there is an excellent asset (property or shares) that you would like to invest in, negative gearing may be an added bonus.
Negative gearing is more advantageous as you reach the higher marginal rates.
If you brought a well-researched property, but the costs of holding that property (Interest, property manager, repairs and rates) are greater than income produced from rent, you will be losing money each year.
Australia is unusual in it’s willingness to let you deduct this “loss” against other income sources, therefore reducing tax paid on your primary income, and reducing your loss in holding the property.
The idea is that the increase in house value over time more than compensates for this loss. The big risk comes with choosing the asset … again, a poorly performing asset completely destroys this strategy.
Doctor Tax Returns
You are able to deduct work related expenses at your tax return.
The average intern receives a small refund (A great starter fund for your emergency fund, house deposit or first investment).
More senior doctors deducting significant amounts annually should consider a PAYG withholding variation to adjust the amount your employer withholds for tax out of each pay.
This allow you pay less tax fortnightly – a great strategy if you are self-controlled and can direct the tax saved into a mortgage offset account.
If you are receiving a $10,000 refund, you are effectively lending the ATO that money tax free. You can bet they won’t return the favour!
If you are a home owner with a mortgage of $100,000 at 3%, you could save yourself ~ $300 in interest over a year by having the tax in your account instead of taken out of your pay.
Medical equipment (eg stethoscope)
Self-education (courses or text books, journal subscriptions)
Branded work uniform clothing (Not regular smart clothes)
Professional indemnity fees
Phone and internet fees for the portion used for work
Laundry expenses for washing work clothes
Home office expenses (eg electricity)
Overtime meal expenses (check specifics with accountant or ATO).
Donations to tax deductible charities
Travel expenses only if you travel between from your place of work to another (Not just a commute to work) – accommodation, flights, food
You will need to record all these expenses and check whether you can claim them.
Have a system for recording your expenses easily. The ATO have an app, but the first year I used it they deleted all my data. I now keep a notes document on my phone with pictures of receipts embedded in document.
Locum Doctor Australian Tax Efficiency Hacks
Travel and accommodation are often covered by the hospital or agency, but if not could be deductable. For irregular locum travel, you may be able to claim cost of food so keep receipts and remember to ask your accountant.
If you earn more than $75,000 as a sole trader, you will need to register for GST, and pay tax quarterly.
If you earn less than that (as I do with irregular locums when dates/hospitals suit), you are able to keep the entire income until your tax is due after June 30.
For fellow mortgage slaves, this money could potentially sit in an offset for over a year! Just remember to put aside how much you may need to pay in tax (I just put 50% of income in a “tax to be paid” offset for simplicity).
Accidentally spending tax owed seems to be a common issue, especially for the 1st year or two of self-employed business, so watch out for this!
Timing Income and Tax Deductible expenses Optimally
This is especially relevant to those with a mortgage offset account, as significant amounts of interest can be saved.
For those under the threshold for GST registration (<$75,000 in ABN income) it is advantageous to earn this early in the tax year – if you could earn $40,000 in gross side hustle income in July and sit this in an offset saving 3.3% you will not have to pay up the tax until September/October of the following year – saving up $1500 in interest!
Similarly, although unlikely as powerful is trying to time tax deductible expenses for the end of the tax year. If you need to buy a new laptop or pay for an expensive course, the want to minimise time between you paying and receiving a tax refund, so your money is in your offset as long as possible.
First Home Savers Scheme
If you’re not yet contributing up to the $25,000 concessional cap (which is taxed at just 15%) to superannuation, and saving for a house, consider using the First home savers scheme to boost your deposit with tax savings.
See the ATO to check eligibility as well as small print conditions.
Mortgage offsets have been mentioned a few times in this article and for good reason!
For those that have a mortgage, putting your savings in an offset will save you more interest (currently 3-4%) than any high interest savings account (currently 1-2%).
Interest earned from a savings account would be taxed at your marginal rate – interest saved is not taxed.
Australian Tax Optimisation Using Discretionary Trusts
Income splitting is illegal in Australia. You are unable to split your personal services income between yourself and your spouse. Sorry! Again, we are back to the disadvantages of having high and low earning partners as opposed to two moderate earners (significantly more tax for the unequal spouses).
Investment income, however, can be far more flexible. Property or shares can be put into a “Discretionary trust” where earning can be distributed to whichever beneficiaries are most advantaged that year.
It is worth thinking ahead, small children now will be university students in 10 years and may attract a marginal tax rate of 0%.
Optimising Tax Efficiency of Australian Income – But NO Tax Avoidance!
It is worth making sure you are optimising tax within the ATO guidelines. Watch out for “tax avoidance” investments or schemes.
Many a doctor has been caught out, motivated to avoid the punitive tax levels associated with personal services income, and lost all their money as a result.
Choose your investment first, then optimise for tax not the other way round.