A dentist, on average, pays over $2.5 million* in tax over the life of their career which is a huge amount considering the average Australian will only pay a fraction of this amount at an estimate of around $500,000. For the average Australian, their largest expense is typically their home loan. For dentists, income tax typically costs more than their home loan.
In this article, I wanted to discuss the tax planning opportunities available to dentist to minimise their taxes. I remind you that the late Kerry Packer once testified in a government inquiry and said “Of course I am minimising my tax. And if anybody in this country doesn’t minimise their tax, they want their heads read, because as a government, I can tell you you’re not spending it that well that we should be donating extra!”
Your main problem
The ATO has something it calls Personal Services Income (PSI). Put simply, PSI is any income that is received as a direct result of your personal efforts and skills. Perhaps it’s easier to explain to compare two stark examples. A PSI example is a dentist that operates solely with only a part-time receptionist (i.e. no dental nurse or hygienists). In this example, if this dentist doesn’t come to work, he doesn’t earn any income. All income this practise receives is a result of his personal efforts and skills of the dentist. Conversely, consider a situation of a dentist that runs a practise that employs 3 commission-based dentists, a hygienist, a few dental nurses and receptionist. The principal dentist (owner) only works for the practise spasmodically (and the practise pays him a commission). In this situation, all the profit earned by the practise would not be classified as PSI – it is simple business income.
So what’s the big deal about PSI? The tax law says that all PSI income must end up in the tax return of the taxpayer that generated it. Essentially, you cannot structure PSI income via trusts and companies to minimise tax. PSI income is therefore taxed at the individual marginal tax rates – with the highest rate now being 49% for income > $180,000 (including Medicare and Temporary Budget Repair Levies)! So, if you want to plan to minimise your tax, try and get as far away from PSI as possible.
You don’t want attract an ATO audit
An important point to make at this stage of the article is to share my views on aggressive tax planning. Some accountants and advisors can come up with complex structures or products to try and minimise tax. I have three comments about this:
>> Firstly, you are the taxpayer and you are the one taking all the risk when you sign and submit your tax return to the ATO. Of course, if the tax advice is negligent, you may have recourse against the advisor but just be aware that it’s your responsibility to understand your personal tax compliance risks
>> A lot of advisors that recommend complex tax structures and products charge high fees. Sometimes it’s their business model to over-complicate things so that they can justify their fees. Also, if the laws subsequently change, you have to pay them more fees to unwind everything
>> In general, you can rarely avoid paying tax with complex planning and structuring but rather just delay it, and pay the same or similar tax later. Therefore, tax minimisation, to a certain degree, is a bit of a misnomer.
My suggested approach towards tax structuring is to take every opportunity to minimise your tax legally but to stick within the black letter of the law i.e. avoid playing in the grey areas. The last thing you really want to do is attract the attention of the ATO and be subjected to a thorough audit as that’s likely to cost you most in the long run.
Commission-based dentists will be subject to PSI (referred to above) which means that all income must be received personally. As such there is rarely a basis for practising via a company or trust structure as the net income needs to end up in your name anyway so structures result in more complexity and cost for no benefit.
The only way to minimise employment income is to ensure you claim all available tax deductions. Typical work-related tax deductions for commission-based dentists include:
- Travel between surgeries/hospitals (if you work at more than one practise). Travel between your home and surgery is not deductible
- Cost of any medicine, supplies and laboratory fees
- Dental Board of Australia registration fee, ADA membership fees, etc.
- Professional Indemnity insurance
- Professional periodicals and library costs
- Telephone expenses, particularly if you are on-call
- Protective clothing and footwear, uniforms and cleaning thereof
- Professional conference, seminars and training courses including travel expenses
- Computer equipment and software used for work (often need to depreciate)
- Tax & accounting fees
- Income protection insurance.
Smaller private practise
A smaller private practise might consist of one practising dentist (you), reception staff and dental nurse. In this situation, it is likely that 100% of the practise’s income would be classified as PSI. The only tax saving measure available is for you to establish a service entity (often a discretionary trust – herein referred to as service trust). The service trust would charge your practise (you) a service fee of up to 60% of gross patient revenue and, in return, pay for all of the practise’s costs excluding only laboratory fees. As a result, it is likely that the service trust would record a small profit of around 10% (i.e. 10% of gross patient fees). As the service trust’s income is not PSI, you will be able to distribute that profit to another family member/s to save tax. 40% of the practise’s income less lab fees will remain in your personal name and be taxed at marginal rates.
Click here for a guide written by the ATO specifically for dentists about structuring a service entity.
Larger private practise
A large private practise might consist of a principal dentist, commission-base dentists, dental nurses, hygienists and reception staff. Therefore, it is possible for the practise to generate a combination of PSI and non-PSI income. The best tax planning structure for a larger practise is to have the company own and operate the practise with the shares in the company owned by a family discretionary trust. The practise company would receive all the patient income and pay for all the expenses including 40% commission to the principal and other dentists. The practise company will then (hopefully) make a reasonable profit and pay a dividend into the family trust. The family trust could then distribute the profit (including the dividend imputation credits) to other family members as tax efficiently as possible.
The best way to save tax is available to everyone
Perhaps the most effective way to save tax is to borrow money to invest (often referred to as negative gearing) and any dentist can do this. Essentially, borrowing to invest converts what would have been taxable income into capital growth, resulting in a higher net personal worth. So it not only saves tax but also increases your wealth.
Let me explain using an example. You purchase a $500,000 investment property and borrow the full cost. Your interest rate is 5% and your investment yield is 3.5%. I estimate the property will cost approximately $13,000 before tax in the first year (i.e. rent less interest less expenses). You can offset this loss against other income which will save you $6,370 in tax. So the actual cost of the investment after tax is $6,630. However, if the property increases (on average over the longer term) at a rate of 8% p.a., the value of your $500,000 property is now $540,000. So in this instance, you are $33,370 better off ($40,000 – $6,630). Essentially, you have converted $6,630 of income into $40,000 of capital (asset). But the real value of this is in compounding capital growth because after 10 years you have accumulated $500,000 in equity and its cost you just over $34,000 in after tax cash flow (and reduced your tax paid by $32,000). It is for this reason that borrowing to invest is very powerful.
Borrowing to invest in just anything isn’t worthwhile. In fact, it’s foolish. You must only invest in quality, investment-grade assets. Otherwise, don’t brother. There are heaps of articles and blogs that I have written about how to select investment-grade assets (click here to read some).
Don’t pay more tax than you need to
Hopefully this article has given you a good overview and understanding on how to save tax as a practising dentist in Australia. It is an important subject that really requires you to seek out professional advice to ensure you are making the most of your opportunities to reduce tax as much as possible. It goes without saying that I’d always welcome the opportunity to have a discussion with you if you are looking for a professional firm to look after your taxes. Click here for more about what I/we do.
Warning: I have written this article so it’s easy to understand. As a result, I have generalised on some points and not have noted any exceptions to rules, loopholes, etc. Therefore, this article only provides you with a general understanding and it should not be a substituted for specific tax advice. Seek professional advice from a registered tax agent before implementing any tax structuring measure.
* Assuming the dentist works on a commission basis for the first 6 years of their career and then starts their own private practise from scratch and, as a result, I assumed the tax rate is capped at 30%. The average Australian estimate is based on average weekly earnings of $1,450 per the ABS ($75k p.a.).