for doctors and dentists
Paying high amounts of income tax is without a doubt the main frustration for many medical professionals. The tax planning options for doctors and dentists are very limited, so it is essential you optimise your tax planning and make the most of the available tax-effective wealth creation strategies.
A very common question for medical specialists in private practice is whether they can split their income with their spouse or other family members. This question is driven by the fact that doctors and dentists pay a high income amount of tax.
Income splitting for doctors and dentists
The idea is to redirect income to a spouse or dependant who has a lower income, to bring the taxable income down to a level where the marginal tax rate is lower than yours, typically 47%.
However, caution is warranted as the Australian Taxation Office undertakes a great amount of audit activity in this area, especially among professionals who use it incorrectly to reduce the tax liabilities of the higher-income-earning spouse.
There are two types of income you may be able to split: passive or active. Passive income is the income earned from investments such as shares or an investment property. Splitting this income with your spouse is generally acceptable from the ATO’s point of view. Passive income splitting is typically achieved by holding investment assets through discretionary family trusts where income can be distributed to low-earning taxpayers, or in the name of low-earning taxpayers, or even a company, which is taxed at a flat 30% rate.
Active income is income you have earned from your own exertion (e.g. your private fees), and splitting this type of income is subject to strict tax rules. It is more commonly referred to as Personal Services Income or PSI. PSI is defined under s84-5 ITAA97 as ordinary or statutory income that is gained mainly as a reward for the personal efforts and skills of an individual. The ATO takes a simple approach to their assessment of ‘mainly’: if the income you earn is more than 50% for your effort and skill, then you classify this income as PSI. Whether this income was earned as a sole trader, or via a trust or company structure is often irrelevant.
The basic rule is that you cannot split the income that you earn from your own personal exertion. The tax office considers that you earned the income, therefore you pay the tax on it.
Hence, the opportunities to direct income away from the medical professional and split it with other individuals or entities are very limited. Generally speaking, all income earned by you must be included in your individual income tax return.
Where you run a private practice and employ multiple staff, or a GP or dentist clinic with other contractors, a greater opportunity for income splitting exists through the use of a service entity.
This is a very complex area of taxation where expert tax advice is required, and unfortunately we still see many cases where doctors and dentists have received incorrect tax advice.
Tax-effective wealth creation strategies for doctors and dentists
There are several tax-effective wealth creation strategies for medical professionals, and when used in combination which each other they can deliver powerful results.
Superannuation is a still an extremely tax-effective investment vehicle, ant it makes sense to aim for the maximum amount of tax-effective retirement benefits that can be accumulated for each spouse ($1.6m).
This can be a powerful strategy early on in your career, as you can leverage your strong income in a tax-effective way. However, rather than focusing on the tax benefit, you need to ensure you buy quality assets that will increase in value, and you also need an exit strategy to retire your debts.
Family trust – savings and investment plans
Family trusts offer tax planning and asset protection benefits, and offer a unique environment to establish savings and investment plans.
Investment bonds can be a simplified alternative to a family trust, but typically have more limited investment options. They are low maintenance though and offer exceptional tax benefits after 10 years.
Tax planning is an important part of our strategic advice for doctors and dentists. We can work with your existing accountant, but also offer and in-house, fully integrated tax and accounting service.
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~ Dr Green
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