One of the most common questions that we are asked is how can I reduce my tax? Let’s face it; nobody wants to pay any more tax than they absolutely have to. Occasionally however, in the quest to minimise tax, an individual becomes confused about the different types of income they are receiving, how this income is taxed and the strategies that are available to minimise their tax bill.
In this month’s article, we will discuss the two main types of income that doctors generate and the issues to look out for when considering your tax strategies.
Professional Income – your bread and butter
Whether you’re an employee doctor, contracting or self-employed with your own practice, the main type of income that will fund your lifestyle and your investments is professional income. This is otherwise known as active income as it involves getting into the rat race and working to receive a reward for your effort. It is also called “personal services income”, as it is income that is earned solely by you, due to your education and hard work.
When considering the application of tax to this type of income, one way to think about it is that if you do the work, you pay the tax. Despite what you may have heard in hospital corridors or dinner parties, there are no tax structures available to legitimately distribute this income to other family members. If they did not do the work, they cannot get the income.
If you are currently using a structure (such as a trust or a company) to receive your professional income, you may be subject to the “personal services income” rules within the tax law that operate to ensure that despite the structure, any personal services income is taxable to the individual who is performing the work.
So what can you do to reduce tax on professional income?
If you are an employee doctor, the key strategies are:
- Using the salary sacrifice concessions that are available to employees of public hospitals to save you at least $3,000 in tax each year;
- Examining how you structure your investments to maximise any personal investment deductions; and
- Maximising your employment deductions.
If you are self employed, the key strategies are:
- Consider the use of a service trust within your business; and
- Examining how you structure your investments to maximise any personal investment deductions.
Investment Income – using your money to make money
Investment income is the opposite of active income. This is income you earn from the investments you have made and is passive in nature. Some examples include rental, dividend and trust distributions. This is income you do not actively work for – it’s the income you generate while you sleep and will fund your lifestyle once you cease work.
When considering the taxation of investment income, remember if you own the asset, you pay the tax. This means that passive income is an area where we can really put our tax planning strategies to good use, as we have a wide variety of choices regarding who should own the asset, depending on the outcome you are trying to achieve.
This means that unlike active income, you have choice as to who will be taxed on investment income and this is where structures such as discretionary trusts, companies and superannuation funds have a significant role to play. The main point to remember, however, is the time to make that choice is prior to purchasing the asset – so make sure you get advice before you start building your wealth.
Whether it’s active income where you do the work and pay the tax, or passive income where you own the asset and pay the tax, it’s vital to ensure that you plan your affairs to take advantage of all of the strategies that are available to help you minimise your tax.
If it’s been a while to since you examined your structures or your strategies, make this the month that you talk to your accountant to ensure your choices are working well for you.
The article is intended to be general in nature and should not be relied upon by any person without seeking advice concerning their own circumstances.