You’ve built your career around your expertise—whether you’re consulting, freelancing, or contracting. But did you know that if more than 50% of your income is based on your personal effort, the ATO might classify it as Personal Services Income (PSI)?
This classification isn’t just a label; it’s a set of rules that could impact your deductions, reporting obligations, and even how much tax you pay. Many people make the mistake of treating PSI the same as other income, only to face challenges when tax time arrives.
This blog will guide you through what PSI means and how it affects your taxes. We will also share the steps you can take to ensure you’re playing by the rules while maximising your tax outcomes.
So, What Exactly Is PSI?
Personal Services Income (PSI) is income earned mainly from your skills, knowledge, or effort as an individual.
If more than 50% of the money you make on a job is because of your work (not equipment, materials, or other resources), it’s likely PSI.
A Quick Example:
- You’re an IT contractor charging a company $5,000 for troubleshooting their system. If $4,000 of that payment is for your time and expertise, it’s PSI.
- On the other hand, if you sold them $4,000 worth of software and only $1,000 was for your time, that’s not PSI.
It’s not about what you do but how the income is earned.
Why Does PSI Matter for Taxes?
Here’s the deal: the Australian Taxation Office (ATO) has special rules for PSI to prevent people from reducing their tax by splitting or diverting this income.
If the PSI rules apply to you, they’ll affect:
- Your deductions: There are limits on what you can claim.
- How you report income: You need to report PSI differently on your tax return.
These rules essentially treat you as if you’re an employee for tax purposes.
Common Mistakes People Make with PSI
“It’s my business income, not personal!”
Even if you operate through a company, partnership, or trust, the ATO might still classify part of your income as PSI. If they do, that income will be taxed like your individual earnings.
“I can claim everything!”
Not exactly. Under PSI rules, some deductions are off-limits, like:
- Rent or mortgage interest for your home.
- Payments to family members (unless they’re doing actual work related to the income).
- Super contributions for your associates unless it’s directly for their principal work.
What Deductions Can You Claim with PSI?
Don’t worry—it’s not all bad news. You can still claim deductions that are directly tied to earning your PSI, like:
- Advertising and tendering costs.
- Registration and licensing fees.
- Insurance costs (e.g., public liability, professional indemnity).
- Salary or super for employees (if they’re unrelated or doing actual work for the income).
Here’s a tip: keep detailed records of your expenses and contracts to back up your claims.
When PSI Rules Don’t Apply
There are some cases where the PSI rules don’t kick in. For example:
- If you run a personal services business (PSB).
- If your income is from a business structure rather than personal effort.
What is a Personal Services Business (PSB)?
To qualify as a PSB, you need to pass at least one of the following tests:
- Results Test: You’re paid for the result of your work, not just your time.
- Unrelated Clients Test: You work for multiple clients who found you through advertising or public offers.
- Employment Test: You employ others to do 20% or more of the work (by market value).
- Business Premises Test: You work from business premises (not your home) that are exclusively for your business.
Passing these tests gives you more flexibility with deductions and reporting.
Why Should You Care About PSI Rules?
Ignoring PSI rules can lead to trouble. If you don’t correctly identify and report PSI, you might:
- Overclaim deductions and face penalties.
- Miss out on opportunities to structure your income better.
Think of it this way: the sooner you understand PSI, the better control you’ll have over your taxes—and your business.
What Should You Do Now?
- Check Your Income: Does more than half of your income come from your skills and effort?
- Use the ATO Tool: The ATO has a free PSI tool online to help you figure out if PSI rules apply to you.
- Get Advice: Tax rules can be tricky. If you’re unsure, talk to a tax professional who understands PSI.
Final thoughts
So, does your income fall under PSI? And if it does, are you handling it in the most tax-efficient way? These are important questions to ask yourself as a freelancer or contractor. The sooner you address them, the better positioned you’ll be to manage your taxes and avoid unnecessary surprises.
Taxes are complex, but they don’t have to derail your financial goals. By staying curious, informed, and willing to seek help when needed, you can ensure that you’re maximising your income and staying compliant with ATO rules.
Disclaimer: This website is designed for informational and educational purposes. Although we exert diligent efforts to maintain the accuracy and reliability of the content, we must disclaim liability for any errors, omissions, or inaccuracies. The content provided is “as is” and is not accompanied by warranties, whether expressed or implied. It should not serve as the sole basis for financial or legal decisions.
Given the evolving nature of financial regulations and conditions, the accuracy and reliability of information may change over time. Users are urged to exercise due diligence and consult with a qualified financial professional for personalised advice. ‘Clear Tax Accountants’ bears no responsibility for direct or indirect consequences, encompassing financial loss or legal matters stemming from the use or misuse of the information on this website.
Please be aware that the information, by no means, is a substitute for financial advice.