Tax tips for consultants and contractors – personal services income
Personal services income (PSI) is income derived in ways similar to that of an employee using their own skills and expertise. The PSI classification was introduced to prevent people from deferring or reducing their personal tax liability, or alienating PSI income via other entities.
Generally, those most affected are individuals working as consultants and contractors, engaged either as sole traders, via a partnership, trust or a company - in any industry, trade or profession, regardless of the number of hours worked. Special tax rules (PSI rules) may apply to this income, and will affect the deductions you are entitled to claim and how you report your PSI to the Australian Taxation Office.
To save time and help you determine whether you have earned PSI income and if the PSI rules apply to you, the ATO has introduced a Personal Services Income Tool.
If you do not pass one of the tests within the PSI classification then, regardless of which entity you use as your trading entity (company, partnership or trust), your contracting/consulting income will be classified as PSI and attributed to you. As an example, you will not have the ability to distribute income to your spouse or your children via a trust or partnership distribution.
In addition, you cannot leave profits in the company to be taxed at a company tax rate subsequently paying a dividend to other shareholders. Your PSI, less your allowable deductions, will be included in your individual tax return and taxed at individual marginal tax rates.
This also means that the deductions claimed against your PSI will be limited to those of an employee.
For more information on taxation matters, or any small business issue, contact the SBDC on 13 12 49.