Doctors earn high income in their personal name and pay a lot of tax, so naturally they are looking for opportunities to minimise it. One of the most common questions we get asked by doctors and dentists working in private practice is “Can I employ my spouse and claim a tax deduction for their wages to reduce my tax?”
While there is no legal reason you cannot employ your spouse or other family members, whether or not you can claim tax deduction for payments in relation to their employment, depends on your circumstances. Apart from tax deductibility, there are number of other important considerations.
1. Are you caught under the Personal Services Income (PSI) Rules?
If you are working as a VMO in a hospital or as contractor in a private practice (whether as a sole trader or operating through a company or trust), you may be caught under the PSI Rules. These are special tax rules applying to doctors, dentists and many other professionals whose income is generated mainly from provision of personal effort, skills or expertise.
The purpose of these rules is to prevent certain contractors from reducing their tax by diverting their income to other people or entities. If PSI Rules apply to you, any payments made to your family members or other associates for performing non-principal work (e.g. administration, practice management, bookkeeping), as well as super contributions made in respect to that work, will not be tax deductible. PSI Rules will not apply if you pass one of the four tests to qualify as a Personal Services Business.
2. Are there commercial reasons for employing your spouse?
It is common for doctors to employ their partners and family members in the business to perform support functions for their practice, such as reception or bookkeeping. If the employment is bona fide and the wages are reasonable, these arrangements are acceptable under the tax law and the payments are deductible. However, artificial employment arrangements created to facilitate income splitting to minimise tax can potentially attract anti-avoidance provisions in Part IVA.
Before employing your spouse or relative, ask yourself whether this would assist you or improve your ability to produce business income or if the main purpose of the arrangement is to minimise tax. As a guide, if you wouldn’t employ an arm’s length employee to do the same job for the same pay, the arrangement is probably tax driven.
Make sure the hours they work are reasonable and reflect the needs of your business. For example, if you are working in a practice under a service agreement and are already paying service fees for facilities and administrative services, it is possible that you might need an extra help of your spouse for a few hours a week to help you with paperwork. However, it would be hard to justify employing your spouse full time on annual salary to do this job.
Keep in mind that that you cannot claim tax deduction if the work performed is of private or domestic nature (e.g. child minding, answering home phone, cooking, cleaning) even if it helps you run your business.
3. Are you paying market rate remuneration to your spouse?
Under the tax law, you can only deduct an amount that is considered reasonable by the ATO Commissioner for a payment you make to your related entities. Make sure that remuneration you pay to your spouse or relative is reasonable and reflects market rates having regard to the duties performed, skills and level of experience.
How do you determine the market rates? A good place to start would be checking award rates for a similar role as well as referring to job listing websites, salary benchmarking reports and surveys.
4. Have you documented your employment relationship properly?
Employers have certain legal responsibilities under the Industrial Law. Just because the person you are employing is a family member, doesn’t mean you can avoid these responsibilities.
Keeping proper documentation is crucial, not just because non-arms-length arrangements are more likely to be scrutinised by the ATO, but also to protect yourself and your business in case of a dispute. Unfortunately, relationship breakdowns are not uncommon.
Having a proper written Employment Agreement outlining legal rights and responsibilities of each party as well as the role description would be a good start. Make sure you also keep copies of timesheets, payslips, evidence of payments of net wages and transfers of super guarantee.
5. Single Touch Payroll and other reporting requirements
Payments to employees, including spouses and other associated persons, are now required to be reported to the ATO through Single Touch Payroll (STP) each time you process your payroll.
To report through Single Touch Payroll, you need an STP-enabled software. The good news is that major cloud accounting software providers, such as Xero or MYOB, are STP-enabled. They also offer payroll only subscription as an inexpensive standalone service if you do not otherwise need a full function accounting software.
If this is the first time you employ someone, you will also need to register for Pay As You Go (PAYG) Withholding with the ATO before you start paying wages. Please note, this is different to PAYG Instalments. PAYG Withholdings are amount of tax you are required to withhold from the gross payments to employees and remit to the ATO. You will need to report the amounts withheld together with gross wages on your Business Activity Statement (BAS) or Instalment Activity Statement (IAS)
6. Super Guarantee Obligations
Regardless of whether you employ an associate or an unrelated person, as an employer, you are required to pay Superannuation Guarantee to a superfund of their choice.
From 1 July 2021, super guarantee is calculated as 10% of Ordinary Time Earnings. It is set to increase to 10.5% from 1 July 2022. From 1 July 2022, employees who earn less than $450 in a calendar month will also be covered by super guarantee obligation.
You can choose to make additional super contributions to increase retirement savings for your spouse.
7. Workers compensation insurance
Workers Compensation Schemes are compulsory and are regulated by each individual state and territory.
For example, in NSW, you are required to get an insurance if you pay more than $7,500 in annual wages. If you fail to take out appropriate workers compensation insurance you may be penalised for up to $55,000 and/or six months’ imprisonment if someone is injured at work.
Check your workers compensation requirements with the relevant authority in your state.
Do you need to get a specialist tax advice specific to your circumstances? Get in touch with us to make an appointment with a Medical Accounting Specialist.