Tax Tip 149: Saving Tax by Splitting Income

Saving Tax By Splitting Income


I thought I would point something out – it is obvious to me, but some people are not aware of this:


There will be less tax payable between 2 people where their tax incomes are the same.


An example:

Income Tax on an income of $200,000 works out to be about $67,947 (2016 tax year, see TaxCalc - Calculate your tax. 2016-2017 financial year)


But tax on an income of $100,000 is just $25,947

Combined tax on $100k income each for 2 people is just 2 x $25,947 = $51,894


So if this couple could structure or split their income in half the tax savings would be $16,053 per year.


It follows that it would be generally be a good idea, from a tax perspective, for a family to split income or divert income from the higher income earner to the lower income earner. This can be between spouses or any adult tax payers such as children.

I will continue with some ways to do this in the next tip.

 

Beware that splitting income to save tax can result in numerous breaches of tax laws. Terry is obviously referring to legitimate splitting such as investment income through a discretionary trust which has been established for purposes of managing family investment assets and holding them separate to the individuals for asset protection purposes.. Example of concerns can include:

• Personal services income cannot be split and may actual limit or deny some deductions. PSI taxpayers cannot pay a spouse or relative in most instances unless that person performs the income producing work etc.
• Paying a spouse in some cases (PSI etc). There are also permitted times you can pay. Specific advice would be recommended
• Paying a spouse who does not perform work, just to split company income
• Use of management fees to divert profits to a lower tax entity or person. eg a sham arrangement with a family company
• Profit diversion to a related entity to split with a spouse
• Specifically forming a discretionary trust for the sole objective of enabling current income to be split with family etc
• Splitting income between spouses to circumvent GST thresholds. ie 2 x ABNs for same primary work and each trade approx $70K pa

One of the best examples is Dave is a plumber. Dave discusses his issue with his mate Alan at a BBQ and then decides to establish a Partnership D & A Plumbing with his wife Annabel. Dave previously traded as a sole trader. Such a arrangement may pose a concern as a tax splitting arrangement. It is governed by Personal Services Income (PSI) rules intended to prohibit such actions. PSI rules do not allow to Dave to pay Annabel other than if she performs plumbing work. She does not. Dave wants to pay her for administration and accounting. Annabel is not an accountant.

Dave then considers using a company as a company only pays a flat 28.5% tax. Again this poses a PSI concern if he did most work for one major employer rather than the public and may also mean that additional statutory obligations such as workers comp, super and possible Division 7A loans to a associate occur. One of the benefits of using a company is the insurance for workers but additional compliance costs will occur too.

Dave seeks proper advice and explains that in two months his son will join him as an apprentice. His adviser may suggest he consider a family trust or restructure at that time as Part IVA is less likely to pose a concern and the trust may provide asset protection if succession of the business is proposed for the future. Part IVA would not likely impact this view.

 

I've buggered up the numbering of this tip - should be Tax Tip 145.

 

Hi Paul,

What are the issues with "

• Specifically forming a discretionary trust for the sole objective of enabling current income to be split with family etc"

I am in this situation, my accountant has setup a corporate-trust to split my business income (180+180)

And i was planning to add a bucket company to the system as my business income will be over 420 this year (180+180+30+30).

I can always say my wife does the internet marketing

 

Do you draw a wage?

 

Prove it

 

I draw from the trust regularly to our join bank account.

 

Doesn't sound like a wage to me.

 

The company provides services to around 500 clients, and I draw profits from the trust which the company trustee of (i think), my wife is also member of the trust.Our accountant set it up that way.

is it a problem ?

 

Well, I am not an accountant, but I think you should be drawing a wage at the very least. Sounds like you are a common law employee. Do you have an employment contract with the trustee? Is the trustee paying super?

The PSI rules need to be considered, but it may pass these.

In the end it might result in the same tax being payable though/

 

Do you have an employment contract with the trustee?
no
Is the trustee paying super?
no I pay it myself

thank you

 

I think you should get a second opinion.

 

Will do

It s the Trust which provides services to my clients, the company is only a trustee.What s the difference between receiving a salary (from the trust??) and and distributing the trust's income ( as the trust cannot have profits for what I understand (or be taxed at marginal)).

I was quite happy with this setup, I am a bit annoyed it could be a breach of tax laws.

Thank you

 

Just as a partner in a partnership cannot be paid wages by the partnership the Commissioner adopts the view that a common law employment does not occur when a trustee director earns income from a trust - This is a mere entitlement to trust income. However that doesnt have to mean a tax problem.

This can create a range of issues and problems such as super contribution issues (or genuine avoidance!) as well as absence of compliance with the Fair Work Act etc.

Add in some issues such as workers comp and failure to correctly resolve to distribute and tax concerns often can arise. Personal Services Income which may affect how taxable income is determined may impact the trust and distributions.

Q : TFN withholding and super guarantee obligations that comply with a regular payment according to a employment agreement all being met ? The ATO would be more likely to address PSI and withholding non-compliance than the issue of wages v trust distributions.

 

One legal issue is that you are doing work and are not being paid for it (directly receiving distributions). This could be an asset protection risk as if you go bankrupt the trust 'owes' you money for work performed.

 

Watch out for the alienation of personal services income rules if you are trying to divert income to a trust, company or a spouse, especially where the income relates to work performed by one person. This seems to be a common issue with 'contractors' in the IT field.

 

Best to pay yourself a "proper" wage plus super - you would be paying tax on trust distributions anyway.

 

Would a formal contractor agreement (with payments etc) be better than an employee agreement?

 

(Slap) sound of a thousand facepalming accountants.

 

Depends