Why Saving Tax is All about Marginal Tax Rates (Almost)

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Why Saving Tax is All about Marginal Tax Rates (Almost)

Saving tax is all about marginal tax rates – almost. When you split, defer, offset, offshore or hide income to save tax – whether this is actually worth the effort depends on marginal tax rates.

2024 Tax Brackets

If you are an Australian tax resident, your 2025 marginal tax rate comes from these five brackets, until there is another change:

  • 0% for your first AUD 18,200
  • 16% for AUD 18,201 to AUD 45,000
  • 30% for AUD 45,001 to AUD 135,000
  • 37% for AUD 135,001 to AUD 190,000
  • 45% from AUD 190,001

Marginal Tax Rate

Your marginal tax rate is the tax rate of the highest tax bracket you hit. Any additional income will be taxed at this marginal tax rate until you hit a new bracket.
You only ever have one marginal tax rate. ONE. Not more and not less. And it is always one of these five – 0%, 16%, 30%, 37% or 45%. Unless tax rates change, of course.
Everybody with an Australian tax file number has a marginal tax rate. Even if you have no income, you have a marginal tax rate. It just happens to be nil if your income is nil.

Income v Marginal Tax Rate

Reducing your income reduces your tax debt. But it doesn’t necessarily reduce your marginal tax rate. Why?
Because marginal tax rates move in jumps from bracket to bracket. So if your income changes within a tax bracket, there is no change to your marginal tax rate.
Let’s say your actual income is AUD 300,000 and now you move AUD 110,000 to your adult children via a discretionary trust. You save tax but your marginal tax rate doesn’t change.
But if your income drops further below AUD 190,000, then your marginal tax rate does change since you now hit a different tax bracket.

Tax Strategy

Why is saving tax all about marginal tax rates (almost)? The answer is about tax arbitrage. The gap between different marginal tax rates.
There are nine ways to save tax and all nine have something to do with marginal tax rates. Not always 100% exclusively, but marginal tax rates are there in all of them.

Summary

So this is why saving tax is all about marginal tax rates (almost). The higher your marginal tax rate, the more you benefit from moving income to lower marginal tax rates and expenses and losses to higher marginal tax rates.

Makes sense? Reach out when you are ready to pay less tax.

PSI, PSE and PSB – Get This Right and Pay Less Tax

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PSI, PSE and PSB – Get This Right and Pay Less Tax

If your business provides a service, PSI, PSE and PSB are the three most important acronyms for you to pay less tax. In short: If you earn PSI through a PSE that qualifies as a PSB, you pay less tax.

PSI

If you mainly get paid for your efforts and skills, then you earn Personal Services Income aka PSI. Mainly means more than 50%.
But if 50% or more of your income is for other things, for example, the machines you use, then you don’t have PSI from that income source. It is an all-or-nothing approach.

PSE

If your PSI income is paid to another entity, for example, a company or trust, that entity is a PSE, a Personal Services Entity. Any entity that is not an individual and receives PSI is a PSE.

The question is whether this PSE qualifies as a Personal Services Business (PSB). If it does, you will pay less tax.

PSB

PSI is taxed like employment income (unless you qualify as a PSB).

You can’t do much with employment income. You can’t defer or split it. You can’t offset it against losses or claim all the deductions a real business could. 

But as a PSB you can do all that. You get treated like any other real business. So you want to be a PSB, because a PSB means less tax.

Makes sense? Reach out if you need help.

Pass a PSB Test To Pay Less Tax

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Pass a PSB Test To Pay Less Tax

If your business provides a service and you want to pay less tax, you have three ways to do that.

1- You pass the 50% PSI Test. The 50% PSI Test looks at whether you even have PSI. Great if you don’t. Then you can stop right here.
2 – You pass one of the four PSB tests and qualify as a PSB.
3 – You ask the ATO for a PSB Determination if you fail the last two PSB tests because you didn’t make it over the 80% hurdle
So let’s look at the 4 PSB Tests.

PSB Tests

To qualify as a PSB you need to pass one of the four PSB Tests.

PSB Test no. 1: 75% Results Test

Do you produce a result using your tools at your own risk for at least 75% of your work?
You need to tick a – Result, b – Tools, c – Risk and d – 75% to pass this test. If you do, you qualify as a PSB and can stop right here.
80% Threshold
To pass one of the remaining three tests, you must earn less than 80% of your revenue from your largest client. If your largest client pays you 80% or more, the law will treat you like an employee. So no PSB.

PSB Test no. 2: Unrelated Clients

To pass you must advertise your services to the public and get at least two unrelated clients as a result of that. This ‘as a direct result’ is important. There must be a causal link.

PSB Test no. 3: Employees

To pass you must have at least one employee who does at least 20% of the principal work – measured by market value. Clerical and administrative work doesn’t count.

PSB Test no. 4: Business Premises 

To pass, you must work out of business premises that are separate from your home and you have exclusive use. So shared workspaces or home offices don’t count.

PSB Determination

If you fail the employees and business premises test because you went over the 80%, then you can ask the ATO to be nice and give you a PSB determination so you can still qualify as a PSB.

Pay Less Tax

Pass one of these four PSB tests or get a PSB Determination to qualify as a PSB and pay a lot less tax.

If you get stuck, please tell us what the problem is.