Income averaging is a concessionary tax treatment available in Australia for certain professionals whose income fluctuates significantly from year to year.
This regime is designed to address the issue of inconsistent income levels, particularly in occupations where earnings can vary widely over time. The goal is to reduce the impact of high tax rates that would normally apply during years of higher income.
How income averaging works
Calculating the Average
To determine the income that qualifies for income averaging, a 4-year average is computed. This average is based on the professional’s assessable income from the current year and the three preceding years. The income above this 4-year average is considered as “special professional income” eligible for the income averaging regime.
Tax Calculation
The special professional income above the 4-year average is then subject to a special rate of tax, different from the regular tax rates. This reduced rate is intended to mitigate the impact of higher tax rates that would apply to the fluctuating income if income averaging were not used.
80-20 Split
The taxable income eligible for income averaging is divided into two parts – the top 80% and the bottom 20%. Tax is calculated separately for each portion.
Tax Reduction
For the top 80% portion of the special professional income, the tax is calculated at a rate that is four times that of the bottom 20%. This ensures that the higher tax burden in the high-income years is reduced, making it more manageable.
Straddling Income
If the portion of income eligible for income averaging spans multiple tax brackets, the averaging formula adjusts the tax to be paid at the lower rate, helping to further reduce the overall tax burden.
Eligibility for income averaging
Income averaging, as a concessional tax treatment, is available to eligible individuals in Australia who meet specific criteria. To qualify for income averaging, you must:
- Residency: You must be an Australian resident at some point during the income year in question.
- Special Professional: You need to be classified as a “special professional.” This typically includes individuals engaged in certain professions or occupations that experience significant fluctuations in income from year to year.
- First-Year Requirements: To be eligible for income averaging, you must meet the first-year requirements. This means that in either the current income year or an earlier income year, your taxable professional income (TPI) as a resident special professional individual must have exceeded $2,500. This initial year, where you first meet the income threshold, is referred to as “year 1.”
Once you satisfy these conditions, you become eligible for income averaging, which allows you to benefit from the concessional tax treatment designed to reduce the impact of higher tax rates during years of higher income.
Types of special professionals
Author or Inventor
This category includes individuals who are creators of original works protected by copyright law. For example, composers, artists, sculptors, photographers, and inventors would be considered special professionals under this category.
Performing Artist
A performing artist is an individual who showcases their talents and skills in front of an audience, engaging in various forms of artistic expression. This includes activities such as:
- Playing music.
- Presenting a play.
- Dancing.
- Providing entertainment.
- Delivering a speech or address.
- Creating a display or exhibition.
- Engaging in promotional activities.
- Participating in artistic events or any similar activities.
Performing artists also include individuals who appear in or participate in recordings, such as films, tapes, discs, or television and radio broadcasts.
In essence, performing artists use their intellectual, artistic, musical, physical, or personal abilities to captivate and entertain audiences, making their art accessible through live performances or recorded media.
Production Associate
A production associate is a special professional who contributes to the artistic aspects of the production process rather than focusing on technical aspects. Individuals who qualify as production associates fall under the definition of “artistic support” and include the following roles:
- Art Director: Responsible for the visual elements and overall artistic design of a production.
- Choreographer: Designs and coordinates dance routines and movements for performances.
- Costume Designer: Designs and creates costumes to enhance the visual appeal and characterization in a production.
- Director: Oversees the creative vision and artistic direction of the production.
- Director of Photography: Manages the camera work and visual aesthetics in film or video productions.
- Film Editor: Edits and assembles footage to create a cohesive and compelling final product.
- Lighting Designer: Designs and implements lighting schemes to enhance the ambiance and mood of a production.
- Musical Director: Oversees the musical elements, such as arrangements and performances, in a production.
- Producer: Manages various aspects of the production, including financing, scheduling, and coordination.
- Production Designer: Designs and oversees the overall visual look and style of a production.
- Set Designer: Creates the visual design of the sets and scenery for a production.
Additionally, any individual who makes an artistic contribution similar to those performed by the listed roles is also considered a production associate.
Sportsperson
Sportspersons are individuals engaged in competitive sports activities where physical prowess, strength, or stamina play a primary role. This category also extends to specific roles in certain sports, such as navigators in car rallying or coxswains in rowing.
Types of professional income
Income averaging applies to different types of professional income, which are categorized as follows:
Taxable professional income (TPI)
TPI is the remaining amount after deducting relevant expenses from assessable professional income. It includes deductions that reasonably relate to assessable professional income and a portion of apportionable deductions. TPI serves as the basis for calculating income averaging.
Assessable professional income
Assessable professional income refers to the income that is directly derived from the activities of a special professional. This type of income is essential in calculating the Taxable Professional Income (TPI) for a special professional. Assessable professional income includes the following:
- Any monetary rewards or prizes received by the special professional for their achievements or accomplishments in their respective field.
- The income earned by the special professional through endorsements, promotional activities, interviews, commentating on events, or providing similar services.
- Income obtained from the rights and royalties associated with the copyright of literary, dramatic, musical, or artistic works that the special professional has created.
- Revenue generated from holding the patent rights to an invention that the special professional has developed.
If you are an author or inventor, your assessable professional income should include the earnings you receive from activities directly related to your professional work. This includes income derived from the following:
- Engagements or Commissions to Produce Specified Works: If you have been engaged or commissioned to create specific literary, dramatic, musical, or artistic works, the income obtained from these projects should be considered as part of your assessable professional income.
- Inventions: Income generated from the commercialization of one or more specified inventions you have created should also be included in your assessable professional income.
- Previous Engagements or Commissions: If you have had prior engagements or commissions to produce works, even if they were not continuous over a substantial period, the income from these projects should also be considered in your assessable professional income.
On the other hand, the following types of income are specifically excluded from assessable professional income for individuals in these professions:
- Any income earned from coaching or training others in sports or competitive activities is not considered assessable professional income.
- Income derived from serving as an umpire or referee in sports events is excluded from assessable professional income.
- Income earned from administering sports events or activities is not part of assessable professional income.
- Income received as a member of a pit crew in motor sports events is not considered assessable professional income.
- Any income earned from being a theatrical or sports entrepreneur, such as managing events or promoting talents, is excluded from assessable professional income.
- Income derived from owning or training animals is not considered assessable professional income.
- Any income received as a superannuation lump sum or employment termination payment is not part of assessable professional income.
- Income received as payments for unused annual or long service leave upon retirement or termination is excluded from assessable professional income.
- Any net capital gain obtained from the sale or disposal of assets is not considered assessable professional income.
Average taxable professional income (ATPI)
ATPI is calculated as one-quarter of the sum of your Taxable Professional Income (TPI) for each of the preceding 4 years. This means that ATPI for the current income year is determined by adding up your TPI for the previous 4 years and dividing it by 4.
However, special rules apply if your first income averaging year was less than 4 years ago.
If the current income year is within the first 4 years and you were an Australian resident in the year immediately before your first year, ATPI is calculated as follows:
- Year 1: Nil (no ATPI)
- Year 2: One-third of TPI in Year 1
- Year 3: One-quarter of the sum of your TPI in Years 1 and 2
- Year 4: One-quarter of the sum of your TPI in Years 1, 2, and 3.
If you were not a resident in the year immediately before your first year, you should contact the relevant authorities for specific guidance on ATPI calculation.
Above-average special professional income
Your above-average special professional income refers to the portion of your TPI earned during the income year that exceeds your average TPI. This above-average income is subject to specific tax treatment under income averaging.
Your tax payable consists of two components:
- Tax on your above-average special professional income
- Tax on your other income (explained in step 1 of the guidelines).
If your TPI is equal to or less than your average TPI, meaning there is no above-average special professional income, you will pay tax at ordinary rates on your taxable income.
Calculating tax payable
To calculate your tax payable with income averaging, you have the option to either have it done by the relevant authorities based on the information provided in your supplementary tax return or to calculate it yourself following these steps:
Step 1:
Add your Average Taxable Professional Income (ATPI) to your taxable income that is not subject to income averaging (your taxable non-professional income).
The total, known as your “other income,” will be taxed at normal rates.
Step 2:
Subtract your ATPI from your Taxable Professional Income (TPI) for the current year to determine your Above-Average Special Professional Income.
AAP Income = TPI (Current Year) – ATPI (Average Taxable Professional Income)
To work out the tax payable on this above-average income:
- Add one-fifth of your above-average special professional income to your “other income.”
- Calculate the tax payable on this combined amount.
- Subtract the tax payable on your “other income” from the tax payable on the combined amount.
- Multiply the result by 5.
Step 3:
Add the tax on your “other income” (taxed at normal rates) and the tax on your above-average special professional income (calculated in Step 2). The sum of these two amounts will be your total tax payable.
Note that you don’t need to perform these calculations yourself on your tax return as the ATO will do this based on the information you provide in your tax return. However, if you prefer to understand the calculations or check the tax assessment for yourself, the above steps can be followed.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.
