Behavior of Self-Employed and Trust Beneficiaries Raises ATO Audit Concerns

Taxpayers in Australia, particularly the self-employed and trust beneficiaries, are leveraging the flexibility of the country's tax system to minimize their tax liabilities, prompting concerns over potential audit risks by the Australian Taxation Office (ATO).

Research conducted by the Australian National University (ANU) and the University of Sydney, analyzing 189 million tax records from 2000 to 2018, has shed light on the prevalence of income "bunching" among taxpayers. This bunching phenomenon, where individuals strategically adjust their taxable incomes to fall into lower tax brackets, is significantly more pronounced in Australia than in other countries.

While progressive tax systems naturally entail some degree of clustering around tax brackets, Australia's system exhibits excessive bunching, particularly among self-employed individuals and trust beneficiaries. According to ANU professor Robert Breunig, co-author of the research, this behavior is not driven by a preference for leisure over income but rather by strategic maneuvers around trust structures, business income, and deductions.

The Australian tax system's unique characteristics, including a wide range of allowable deductions and stable tax regulations over the past two decades, provide taxpayers with ample opportunities to manipulate their taxable incomes. This flexibility allows individuals to target specific taxable income levels to minimize their tax liabilities.

Significant bunching occurs at various income thresholds, with notable spikes observed when tax brackets are adjusted. For example, when the tax bracket was raised from $150,000 to $180,000, many taxpayers previously earning just under $150,000 experienced a sudden increase in income close to the new threshold. This increase was often attributed to distributions from companies or trusts rather than actual increases in earned income.

Moreover, the research highlights demographic variations in income elasticity, indicating differing behavioral responses to tax rates among various groups. Married females, females with children, younger individuals, and those with greater income-shifting opportunities within their households exhibit higher income elasticity. Such demographic differences are not observed among salary earners and are believed to stem from females' higher likelihood of being secondary earners.

Breunig emphasizes that the prevalence of bunching is symptomatic of deeper issues within the tax system, rather than being inherently problematic itself. However, he underscores concerns about the complexity of the tax system, which enables certain individuals to exploit loopholes and avoid paying their fair share of taxes.

From the perspective of the ATO, such behaviors raise red flags for potential audit risks. The strategic manipulation of taxable incomes, especially through complex trust structures and deductions, may invite scrutiny from tax authorities. As Australia grapples with addressing tax avoidance and ensuring fairness in the tax system, these findings underscore the need for greater oversight and potential reforms to mitigate audit risks and uphold tax compliance.