One of the greatest challenges faced by new partners in professional services firms is managing their tax obligations effectively in the period immediately after entering the partnership.
If a new partner is admitted to a partnership on the 1st of July, they will typically experience what may be described as a ‘tax holiday’ which can extend for a period of up to 21 months from the date that they ceased being a salary earner. At this point, the new partner will need to lodge their first tax return as a non-salaried taxpayer (ie 21 months after being admitted as a partner).
Upon lodgement of this latest tax return, the Australia Taxation Office (ATO) will realise that this tax payer hasn’t paid any PAYG tax instalments for the last 21 months. The ATO will issue an assessment for the tax liability due on the tax return that was recently lodged. A few months later in July, the ATO will issue and PAYG instalment notice for the ‘estimated’ tax liability for the financial year just ended. This payment is due notwithstanding the fact that a tax return hasn’t been lodged for the year just ended, and might not be due for lodgment until the following April!
In summary, after a period of up to 21 months of ‘flying under the radar’ of the ATO, the new partner will need to pay the equivalent of 2 years of income tax between month 21 and 24 post their admission to the partnership.
Here is a timeline that describes the sequence of events and tax payments
This situation can be daunting, especially for a new partner without proper preparation. Having worked closely with new partners in professional services firms over many years, we’ve seen first-hand how critical proactive tax planning and cash flow forecasting can be in making this transition from salaried employee to partner manageable.
Challenge of ongoing tax planning as partner income increases
One could be mistaken for assuming that once a routine is in place, managing tax obligations becomes a simple and predictable process. In theory, that would be true if a partner’s income remained consistent from year after year.
However, in reality, new partner income typically increases over time. As a result, the ATO continually recalculates PAYG instalments to reflect the rising income — creating an ongoing cash flow challenge.
Our experience in working with partners in professional service firms has shown the importance of income tax projection planning and monthly cash flow forecasting. This proactive approach helps ensure you’re prepared for changing tax commitments and can maintain healthy cash flow throughout the year.
If you would like to discuss income tax planning, please feel free to get in touch.
