What is Income Averaging?

As a creative professional, it’s important that you seek to understand the concept of Income Averaging. This tax treatment offers significant concessions, and knowing how to make the most of them can save you a lot of money at tax time.

And sometimes, as a Creative Professional, your income and cash flow are ‘lumpy’, with periods of low or no income, followed by ‘the great years’. Years of effort, that result in a large cash payment in one year – and a large tax bill as a result.

It is okay if you are not familiar with this particular area of taxation. This is a highly specialised field that only a select few have expertise in. Many accountants, unless they have a specific focus on creative industries, may not be aware of it. Moreover, if you typically handle your tax returns on your own, it is unlikely that this benefit has come to your attention.

Here’s how it works: your Special Professional income from creative sources (such as writing, performing, or inventing) is isolated and taxed at a concessional or reduced rate based on a rolling 5-year average. This means you pay less tax in years where your income from these sources is significantly above average. In years where your income is below or in line with your average, you are taxed at normal marginal tax rates. Keep in mind that income from other sources is always taxed at normal rates, and income averaging may not benefit you in years where your income is below average. However, years of lower income will affect your rolling average, and reduce your tax rate in future periods when you earn above-average income.

To be eligible for income averaging, you must be considered a “Special Professional,” which includes authors, artists, composers, inventors, performers, production associates, and sportspersons. This designation may also apply to those in a “creative decision-making role” such as a director, depending on the circumstances. Eligibility is determined on a case-by-case basis, so it’s best to consult with a tax professional to see if you qualify.

One of the reasons these professions are included in income averaging, is due to the inconsistent nature of income. For example, a composer may spend years developing a project before receiving any income, resulting in large peaks and troughs of income year to year. Income averaging helps to spread this income over the entire development process, resulting in lower overall tax payments.

In simple terms, Income Averaging allows you to smooth out your taxable income over a few years, minimising the impact of any one high-earning period. By doing so, you can reduce your overall tax liability and free up funds to invest back into your creative pursuits.

In the first 4 years, the benefit can be even greater! It is quite common for the first year of averaging to result in little or no tax needing to be paid – at least on the earnings up to $90,000 (assuming no other income has been earned on salary from areas like school teaching, waiting tables or other non-artistic employment).

Keep in mind that income averaging is an opt-in system, and once you opt-in, you remain in the system. You can start using income averaging once you’ve earned more than $2,500 from creative work, and it only considers income generated from creative activities to calculate your average. Other income, such as non-creative activities or investments, is not included.

Okay, you say, so what sort of benefit can this provide?

Case Study 2

Mariah Carey(1) is a professional writer.

On their Tax year professional income of $91,500, and a net taxable income (after all deductions, and including non-business income) they paid tax on a Taxable income of $57,746.

Before using the Artist Averaging provisions, they are liable for tax totalling $9,460.65.

Artist Averaging was then applied to this return, and with the provisions for the first year of averaging, their total tax liability was reduced to $1,154.92 – a saving of $8,305.73 on the same taxable income.

It’s important to remember that you cannot opt-out of income averaging once your income normalises. Also, the concession only applies in “good” years – you will not be taxed more in years where you earn less than the rolling average.

I.e. if your income has been consistently around $80,000 p.a. but then drops in one year to under $40,000, you will pay the ‘standard’ tax you would normally pay on $40,000 for that year. Subsequently, if the following year jumps up to $120,000 (as the project you have been working on is completed and you are paid a lump sum on completion, or the unit sales happen in the following year) then Artist Averaging may reduce the tax payable on the amount ‘over’ $80,000, so your tax rate payable does not jump up significantly.

To show how this works over a number of years, let’s consider the following case study.