This article is the second in a series that looks at accounting issues relevant to musicians and industry professionals. Read Part One here.
For many people who work in the industry, it’s rare that your income for one year will match the year before. If you’re a musician, you may spend one year on the road touring hard and generating a lot of income – but what if the previous year was spent working on your album, and consequently not performing as much? You could be up for an exorbitant tax bill in your second year, even though your income generated was only possible because you worked less the year beforehand. That’s where income averaging comes in. We spoke to Fardad Nejati from One Accounting about what income averaging is, and how it can benefit those working in creative industries.
What is income averaging?
“Income averaging is a system of making tax fairer for professions of varying income”, says Nejati. While people employed in “conventional” professions with a salary can expect to be on roughly the same salary the year after, some professions – officially referred to as “special professions” have varying levels of income every year. The categories this includes are ‘author’, ‘performing artist’, ‘production associate’ and ‘sports people’.
As Nejati explains, “this puts them in a position where they will be up for a higher tax bill in the year they did work regularly, even though in the year before they were working on their art in order to set themselves up”.
The reason for this relates to the tax-free threshold. Someone who earns $100,000 in one year and nothing in the second would have a lot of tax to pay in the first year and nothing in the following. On the other hand, if someone earns $50,000 in the first year and $50,000 in the second year, the amount of tax they would pay overall is much less.
The ATO is recognising that this system isn’t quite fair. As a result, income averaging attempts to alleviate the disadvantage for special professionals whose “off” years – say, the year you spend working on a record instead of touring – contribute to the more active, income-generating year that follows.
How does it work?
For many people, filling out your tax return is a fairly straightforward process – you go in, click through and it gets done. However, when it comes to claiming income averaging it’s a little bit more difficult.
“The income that you report – it’s not just what you earned from performing,” says Nejati. “You’ve got to actually reduce it by some of your deductions but not all of them. So your average performance income is kind of a mish-mash of some of your deductions but not all. As an example, your tax agent fee, if you’re claiming them in one year, you would apportion some of them against it as well.”
“You basically average your income over five years. Depending on what your income is for all of those years the most you would pay is your average of the last five years. The first few years are a little bit different, but essentially it’s a rolling five years.”
Should I see an accountant?
If income averaging sounds a little puzzling, that’s because it is. “It’s a small part of the overall thing, but ultimately, it’s a little bit complicated if you’re trying to do it yourself”, says Nejati.
If the idea of trying to work income averaging out yourself without professional advice fills you with anxiety, it’s important to get someone to help you with it – because getting it wrong can have significant consequences. Going to a firm like One Accounting that understands special professions can assist you with every step of the process – including trickier things like income averaging – and help you get the best possible outcome you legally can.
This article is the first in a series of articles that looks at accounting issues relevant to musicians and music industry professionals – check out Part One for more advice from Fardad and One Accounting., or email him at [email protected]