As a doctor or healthcare professional you likely fall into the top marginal tax bracket which tends to attract an equally hefty tax bill. It is not uncommon for doctors to become blinded by all the money flowing into the coffers and so base spending decisions on gross earnings. Unfortunately, this can lead to you being over-committed financially, a scenario that is sorely evident when your business activity statement (BAS) arrives.
Another factor impacting this dynamic is that doctors operating their own surgeries or medical practices do not qualify for the 30% company
tax rate on any “personal services” income they generate. Doctors must, therefore, expand their thinking when it comes to slashing their tax
bill. The good news is there are several tax-friendly options at your disposal, including self-managed super funds (SMSF) and various
Contributing to your SMSF remains one of the most effective vehicles for reducing your tax liability regardless of your employment arrangements. It does involve a willingness to sacrifice on your immediate take-home salary as your contribution will come out of your pre-tax income. That portion of your income which is contributed to your super fund will be subject to a 15% tax rate as opposed to the marginal tax rate of up to 46.5% to which your regular income is subject. Be aware though that, since 1 July 2012, doctors earning more than $300,000 are subject to a 30% tax rate on their SMSF contributions.
However, tax-effective tactics relating to your super fund don’t end there. Doctors aged 60 years and older could consider a transition to retirement (TTR) pension using the money in their SMSF. A TTR pension enables you to withdraw up to 10% of your super funds annually while still employed. Another bonus of this approach is that withdrawals from their SMSF are considered tax-free. Should you fall into this category, this means you can withdraw from your superannuation account while simultaneously salary sacrificing and contributing to your SMSF at a tax rate of 15%, or 30% in the event your take-home pay is greater than $300,000 annually.
Another perk offered by your superannuation account is that it can serve as collateral to secure a loan which may, in turn, be used to purchase property in the name of your SMSF. [For more information on this topic, read our article How to get a foot on the property ladder with limited funds.] In this instance, you can again benefit from the tactic of salary sacrificing and use your contribution money to repay the property purchase loan.
Put another way you would realise 85c on the dollar for every dollar used to repay the loan via your SMSF versus as little as 53.5c on the dollar if you had purchased the property using a personal loan account, also bearing in mind your take-home pay is subject to a 46.5% tax rate. Ultimately, this means you’ll be able to repay the property purchase loan far quicker inside your SMSF.
Another upside of this approach is that you can arrange the transfer of ownership of your surgery or medical practice property into your
SMSF without paying stamp duty and incurring only a minimal capital gains tax. Once the property is inside your SMSF, it is taxed
concessionally, meaning any rent paid into your super fund will be taxed at only 15c on the dollar. Furthermore, when you retire and convert
your SMSF into a pension, any income generated by the property will be considered tax-free plus any capital gains you realise when the
property is sold won’t qualify for taxation.
Service and investment trust structures
While the government plans to reform how trusts are taxed, such business structures are considered an established and legitimate tax reduction tactic, provided they adhere to accounting guidelines.
Service trusts are ideally suited to doctors running a surgery or practice with a small staff contingent. A service trust is allowed a “make-up” profit of 10% which can be redistributed to family members who are subject to lower marginal tax rates. For example, a partner who handles minor administrative tasks for your practice and so qualifies for a moderate salary. Ensure you’re clear regarding your motives when setting up this type of structure, so you don’t fall foul of the ATO.
An investment trust is another type of trust which can offer tax reduction benefits. The idea behind the investment trust is that it can be set up, so you don’t have to buy assets in your name. It also allows for the redistribution of income and capital to beneficiaries, including family members, who earn a low or no income. The result is that you’ll pay lower capital gains tax in the event you sell the assets before you retire.
Super funds may be the most tax-effective vehicle available, but an investment trust is a more flexible arrangement. A further option for doctors who operate through a trust and who have multiple income sources is to designate a company as a beneficiary. Under the investment trust, this company is designed to “hold” income generated by your business excluding any “personal services” income which you’ve earned. These additional income sources may include service trust income and complementary healthcare services like physiotherapy or specialist nurses. Because it is a company, it will be taxed at 30% versus the up to 46.5% to which your personal income is subject.
Practices and surgeries are evolving from traditional business models meaning income from add-on services should be tracked separately to
ensure they are handled appropriately in terms of taxation.
Other tax-effective options
Due to doctors’ overwhelming tax obligations, they tend to favour investments which promise short-term benefits to the detriment of their long-term interests. The global financial crisis (GFC) appears to have curtailed this trend somewhat, forcing people to focus instead on sound, long-term assets.
While negative gearing seems a sensible tactic from a tax reduction perspective – with people who are eligible for a higher marginal tax rate standing to reap the most significant rewards – it relies on steady capital growth to pay off. Since the GFC and COVID-19, there has been a downturn in capital growth which means negative gearing into shares and property hasn’t quite panned out, causing people to lose confidence in this approach. Coupled with its need for upfront cash as well as the general uncertainty regarding European and US financial markets, it is no wonder that the negative gearing tactic is not as popular as it once was.
The volatility that has seen investors move away from investing in shares and property has in turn seen an increasing focus on more
conservative, income-generating assets like fixed-interest and term deposit options. But investment choices are not a one-size-fits-all
cure, so it is best to consult with your accountant or an expert adviser before implementing any investment tactics which involve negative
gearing or the borrowing of cash.
Minimisation vs. avoidance
While some tax-reduction strategies might be considered technically legal, they may still be viewed as falling short of the spirit of the law and therefore be classed as tax avoidance. So, how can you ensure you stay on the right side of the law – concerning your potential business structure or choice of investment?
If in doubt, you can refer to Part IVA of the Income Tax Assessment Act which features a three-point test to help you determine how the ATO might view your specific circumstances.
Take the following two scenarios:
1. You run a practice which employs one extra GP, and you subsequently institute a service trust structure to gain a tax benefit, that would be classified as tax avoidance. On the other, if the reason you established the service trust structure was to draw GPs to your practice, it would not.
2. Or if you transfer an asset into your family trust to realise a tax advantage, it would be deemed tax avoidance. However, if the reason you migrated the asset into your family trust was to protect it in the event of being sued, it would not.
Ultimately, the onus is on you to ensure your tax minimisation tactics are legal. If your motivation for engaging in elaborate schemes is to
avoid your tax obligations, you’re going to fall foul of the law.
Like many professionals, doctors are attracted to investments which promise a tax benefit. But it’s vital that schemes which sound too good to be true be approached with caution. Here are some of the warning signs that your dream scheme is, in fact, a scam:
The Money Smart website carries an up-to-date list of scams and how to identify them.
It is only natural to want to reduce your tax bill. SMART Business Solutions are on hand to assist you in this capacity without incurring the wrath of the ATO or being slapped with heavy penalties. We have the expertise to help you keep your medical practice in great financial shape meaning less stress for you, your partners, staff, and patients. Contact us today on 03 5911 7000 to request a financial health appointment.
Directors will be required to register for a unique identification number that they will keep for life, much like a tax file number under a rewrite of Australia’s business registers.
How a trust distribution resolution is worded directly impacts the tax liability. It is important not because it determines what is taxable but because it is the basis for determining where the tax liability falls.