Does paying for tax advice save money? Only if you are rich

If you use a tax advisor to complete your income tax return, you are not alone.

Australians use tax advisors more than any other country except Italy†

It’s easier, less stressful, gives you confidence that the job is being done right and saves time.

But will it save you money? Our research says no, unless you’re one of Australia’s wealthiest individuals.

If you’re a typical salaried employee, paying a tax advisor will likely increase your eventual tax liabilities even after you file a tax deduction for the advisor’s fees.

After analyzing 5 million individual tax returns over a four-year period, we found that tax advisers act more as ‘tax exploiters’ for wealthy clients, but as ‘tax enforcers’ for the rest of us.

For clients with annual taxable income over $180,000, whose financial affairs make tax rules complex or uncertain, tax advisors can help identify ways to save money. But for ordinary wage earners, they mainly ensure compliance with the tax rules.

Greater advantage for the rich

Our survey is the first to explore this topic with the help of the Australian tax authorities ALife dataset† This includes a randomly selected (and anonymised) sample of 10 per cent of all Australian taxpayers (approximately 1.4 million observations per year).

The analysis of this data shows that professional tax advice is very useful for the very wealthy to reduce their tax liabilities. Plus, they get a tax deduction when paying for that advice.

Those with the highest levels of supplemental income — that is, business income, rental income, personal service income, and income from partnerships and trusts — undertake more aggressive tax avoidance than lower-income individuals.

The more money is spent on tax professional services – and thus the higher the deduction – the greater the chance of aggressive tax avoidance behavior.

In fact, the tax deduction disproportionately helps the wealthy to minimize their taxes.

Should the deduction remain?

This raises an important question. Should the tax system provide generous tax deductions that only really benefit wealthy taxpayers in their pursuit of minimizing taxes?

A solution would be to abolish this tax deductibility altogether.

Instead, we propose a $3,000 cap on the amount that can be deducted for paying tax advisors. Currently there is no limit.

The Labor Party proposed such a reform in 2017, under Anthony Albanese’s predecessor Bill Shorten.

The Australia Institute supported this with research showing that only those with incomes over $500,000 are likely to be affected by the $3,000 limit. The median (average) deduction for tax advice was $378, and the median deduction only $165.

Ahead of the 2019 elections, the Parliamentary Budget Office estimated the cap would save about $120 million a year, increasing to $130 million a year in 2022-23. However, after Shorten’s election loss, the policy was scrapped.

Maintaining Integrity

Of course, with such reforms there is always the danger that taxpayers and their advisers will look for ways to get around the new rules.

U.S previous research indicates that tax advisers may be trying to circumvent the deduction limit by shifting expenses to other items in an income tax return.

For example, instead of claiming tax consultancy fees on a high net worth taxpayer’s personal tax return, they can assign the fees to a related entity, such as a trust or company controlled by that individual.

But this is not an insurmountable problem. There are ways to prevent such manipulation through so-called “ring-fencing” rules.

For those of us who rely on a tax advisor for convenience and security, nothing needs to change.

Youngdeok LimSenior Lecturer, Accounting, UNSW Sydney† Ann Kayis KumaroColleague Professor, UNSW Sydneyand Chris EvansProfessor, School of Taxation ＆ Corporate Law, UNSW Sydney

This article was republished from The conversation under a Creative Commons license. Read the original article†