The ATO's Secret Club A Guide to Income Averaging

Welcome, to the Podcast! Our newsletter made easy! Please note, this podcast features AI-generated voices for your hosts, Mia Taylor and Leo Baker, bringing you expert insights from owner, Ben De Rosa, at Aevum Accounting. Each week, we're here to help you confidently navigate the ins and outs of Australian tax – whether it's for your individual finances, or the complexities of your business. We'll cut through the jargon to give you strategies for compliance, smart planning, and that ultimate peace of mind. So, if you're looking to understand your obligations, maximize your financial position, or simply gain clarity on your money matters, you're in the right place. Let's get started with our review of the week! Craig and Lisa McLean said "We have been lucky enough to visit Ben every year at tax time for many years. He provides so much more each time and his knowledge and experience has made a difference to our financial outcomes. We value his words of wisdom and the extra time he provides for us." Thank you for the amazing feedback Craig and Lisa! We love hearing from our clients and a positive review gets our podcast started on the right foot. And we are back! Leo Baker here, and today, Mia, we are venturing into one of the most niche, and frankly, one of the coolest corners of the entire Australian tax system. That’s right, Leo. We're not talking about your everyday deductions today. We are talking about a special set of rules for a very special group of people. The topic is Income Averaging for Special Professionals. It sounds exclusive! Like there's a secret club in the tax world, and we're about to find out who's in it. So, what is a "special professional" in the eyes of the ATO? Are we talking about spies? Not quite, although that would be fun. The ATO has a very specific list. We're talking about authors, inventors, producers, artists, playwrights, and elite sportspeople. It’s a category for people whose income can be incredibly "lumpy." Lumpy? Like a bad milkshake? Exactly. Think about it. An author might work for three years on a novel with very little income, and then suddenly receive a huge advance from a publisher in a single financial year. A professional golfer might have a quiet year and then win a major tournament with massive prize money. Right. So if they got taxed on that one huge year like a normal person, the high marginal tax rates would absolutely crush them. It wouldn’t be a fair reflection of their income earned over several years of effort. You've hit the nail on the head. That's the entire purpose of this special rule. Income averaging is a tax concession that allows these special professionals to even out their income over a number of years. This ensures that their big "lumpy" year isn't taxed unfairly at the highest possible rates. It’s the ATO’s way of acknowledging the unique nature of their careers. Okay, so who is in this exclusive club? You mentioned a few. Let's run through the official list. You need to perform your activities in Australia or be a resident of Australia to qualify. The list includes: Authors and inventors, which is quite broad. It also includes performing artists – so actors, dancers, musicians, singers. Production associates like artistic directors, choreographers, or camera operators are also on the list. And finally, the category of Sportspersons, which includes professional sportspeople, coaches and trainers. So, a best-selling author, a rock star, and the person who wins the Brownlow Medal are all in the same tax club. I love it. How do you actually qualify for this? Is it automatic if you’re on the list? No, and this is the most important gateway rule. To be eligible to start using income averaging, there has to be a 'first year'. This is the first income year in which your taxable professional income is more than $2,500. If your income from these special activities has been above that threshold for years, you can't just decide to start now. So you need to have a breakout year. It’s a one-time entry point into the club. Precisely. And once you’re in, you’re in. Your income is averaged for all the following years, whether it's a good year or a bad year. This sounds like it could get complicated. I think we need an example to bring this to life. I agree. Let’s create a fictional author. Her name is Jane. Jane has been writing for years, earning a little bit of money here and there from short stories, let's say about $1,000 a year. In the 2025 financial year, after years of hard work, she finally sells her debut novel and gets a massive advance. Let's put some numbers to it. In the 2025 financial year, Jane receives a $101,000 advance from her publisher. For simplicity, let's say she has no other income and no deductions. So her taxable professional income is $101,000. Okay, so this is her 'first year' because it's the first time her professional income has jumped over that $2,500 threshold. She's in the club! If she was taxed normally, she’d pay a huge chunk of that in tax. She would. But because she’s a special professional, the ATO calculates her tax differently. They split her income into two parts: her 'average income' and her 'abnormal income'. The first step is to work out her average income. In this first year, her average income is simply her taxable professional income, so it's $101,000. Her 'abnormal income' is the amount of her income that is above her average. In year one, since her total income and her average income are the same, her 'abnormal income' is zero. Okay, so in year one, it doesn't seem to make a difference. Correct. In the first year, there's no benefit. The tax is calculated on the full $101,000. The magic happens in the following years. Let’s fast forward to the 2026 financial year. Jane has a much quieter year. She's busy writing her second book and only earns $20,000 from some festival appearances. So, her taxable professional income for 2026 is $20,000. What happens now? Now we calculate her new 'average income'. The ATO looks at her professional income for up to the last four years. In this case, we only have one prior year – the 2025 year where she earned $101,000. So her average income is now $101,000. Since her income of $20,000 is less than her average, her abnormal income is again zero, and the tax is calculated on her actual income of $20,000. No averaging benefit yet, but we are building the history. Now, let’s go to year three, the 2027 financial year. Jane delivers her second book and gets another huge advance of $150,000! A massive year! Okay, let's do the steps. What's her average income now? Her average income is the average of her professional income from the previous two years: the $101,000 from 2025 and the $20,000 from 2026. The average of those two is $60,500. So, for 2027, her 'average income' is $60,500. Okay, and her actual income is $150,000. So now she has 'abnormal income', right? Exactly! Her 'abnormal income' is her total professional income of $150,000 minus her average income of $60,500. That gives us an abnormal income of $89,500. And this is where the concession finally kicks in. The ATO calculates the tax in a special way. First, they work out the tax on her 'average income' of $60,500 at normal marginal rates. Then, they work out the tax on just one-fifth of her 'abnormal income'. They take the tax calculated on that small slice and multiply it by five to get the total tax on the abnormal income. Finally, they add the two amounts of tax together to get her total tax bill. That is a wild calculation. So by taxing the abnormal income in that weird five-slice way, what does it actually achieve? It achieves a much lower tax rate on that big lump of abnormal income. Instead of that $89,500 being taxed at her highest marginal rate, it's effectively taxed at a much lower, blended rate. It smooths out the massive spike in her income and results in a significantly lower tax bill than if she was taxed as a normal individual. That's a fantastic illustration. To really hammer this home, can we run through another example? Maybe one of the sportspeople? Great idea. Let's create "Chris the Athlete." Chris is a professional tennis player. For years, he's been grinding it out, earning a bit from smaller tournaments, but never more than $2,500 in a year. Then, in the 2025 season, he has a massive breakthrough. He wins a major tournament and his prize money for the year is $200,000. He also signs a big sponsorship deal with a sportswear company, who pay him $100,000. Okay, so his total cash in the bank is $300,000. Is all of that "special professional income"? No, and this is a critical distinction for athletes. His 'taxable professional income' only includes income from the direct exercise of his skill. So, the $200,000 in prize money qualifies. However, the $100,000 sponsorship deal is considered income from an endorsement, which is specifically excluded. That $100,000 is just normal income and is taxed separately. Right! So his 'first year' is triggered by the $200,000 in prize money. Like Jane, he gets no averaging benefit in year one. Correct. Now let's go to 2026. Chris has a tougher year on the court, with injuries, and only makes $30,000 in prize money. His sponsorship income stays the same at $100,000. His average professional income, based on the prior year, is $200,000. Because his current professional income ($30,000) is less than his average, his abnormal income is zero. His total taxable income is his prize money plus his sponsorship, so $130,000, and it's all taxed at normal rates. Okay, so the averaging calculation is only happening in the background on that prize money. The sponsorship income is just sitting off to the side, being normal. Perfectly put. Now for 2027. Chris is back in top form and wins another big title. His prize money for the year is a huge $500,000. His sponsorship income is still $100,000. Here we go. Let's do the maths. What's his average professional income? It’s the average of the last two years of *professional* income only. So, the average of $200,000 from 2025 and $30,000 from 2026. That gives him an average income of $115,000. And his professional income this year is $500,000. So his abnormal income is massive! It is. It’s $500,000 minus his average of $115,000, which equals $385,000. So, to work out his tax, the ATO calculates the tax on his total normal income, which is the $100,000 sponsorship plus his average professional income of $115,000. Then, they do the special five-slice calculation on the abnormal income of $385,000 to tax it at a lower effective rate. That is a phenomenal benefit. It probably saves him tens of thousands of dollars in tax. This brings up some interesting questions, though. What if Jane the Author also had a part-time job at a bookstore to make ends meet? Or what if Chris the Athlete had a really bad year and actually made a loss after paying for his travel and coaching? Those are excellent questions, and they get to the heart of the complexities. Let's tackle the part-time job first. The income averaging calculation is done completely separately from any other income. So if Jane earned, say, $30,000 from her bookstore job, that income is just added to her final taxable income after the averaging calculation has been done on her professional income. The two streams are kept separate until the very end. So it doesn't interfere with the averaging, it just adds to the final tax bill. What about making a loss? This is where it gets really interesting. Let's say in one year, Chris's expenses for travel, coaching, and equipment were $50,000, but he only made $30,000 in prize money. He has a net professional loss of $20,000. For the purposes of calculating his average income for future years, his professional income for that year is treated as nil, or zero. It doesn't become a negative number that drags the average down. So a loss year doesn't punish you in the future by lowering your average. And can he use that $20,000 loss to offset his sponsorship income? Yes, he can. The loss from his professional activities can be offset against his other income in that year, like the sponsorship money, which would reduce his overall tax bill. So even in a bad year, there's a benefit. This is a deep rabbit hole! It feels like a system you're in for life. Is there a way out? What happens when Jane decides to retire and spend her royalties on a cruise ship? That brings us to the final chapter: ceasing the activity. There are a couple of ways the income averaging can stop. The first is by choice. If a special professional has been in the averaging system for at least 10 years, they can make a written election to the ATO to permanently withdraw from it. So after a decade, you can say, "Thanks for the ride, I'm out"? Why would you do that? You might do it if your income becomes very stable. For example, if an author stops writing new books and just receives a steady stream of royalties each year, that income isn't "lumpy" anymore. In that case, it might be simpler or even slightly more beneficial to be taxed at normal rates. But you must be careful, because once you're out, you can never get back in. It’s a one-way ticket. What’s the other way the averaging stops? The other way is permanent retirement. If a special professional permanently retires from their profession and notifies the ATO, the averaging provisions will no longer apply from the following financial year. For example, if Chris the Athlete officially retires from tennis in March 2030, the 2029-30 income year will be his last year in the averaging system. So what happens in that final year? Is there a final calculation to square everything up? There is. In the year of retirement, a final calculation is done to ensure the tax paid over the years is fair. It's complex, but essentially, it ensures that the artist or sportsperson gets the full benefit of the concession on any "abnormal" income they earned in their final year. It’s the system's way of making sure the farewell tour or the final prize money is still treated concessionally. So it’s a complex but incredibly valuable provision for a very specific group of people who have those 'lumpy' careers. That's it. It’s a perfect example of why tailored, expert tax advice is so important. This is not something you would ever figure out on your own. You need a professional who understands these niche areas of the law to make sure you're not only compliant, but also getting the full benefit of any concessions you're entitled to. It’s about knowing the secret rules of the club! A fantastic place to end. And that brings us to the end of another episode! We hope today's discussion has provided you with valuable insights and helps you navigate your financial world with greater confidence. Before we go, a quick but important reminder: The information and strategies shared on this podcast are for general informational purposes only and do not constitute specific tax or financial advice. Everyone's situation is unique, and tax laws are complex and constantly evolving. For personalized advice tailored to your specific individual or business needs, we always recommend consulting with a qualified professional. You can connect with our team at Aevum Accounting visit our website to learn more. Thank you so much for tuning in! If you enjoyed this episode, please consider subscribing, leaving us a review, and sharing it. Until next time, stay savvy, stay proactive, and keep building your financial future! From all of us at Aevum Accounting, goodbye for now!