The facts of personal service income (PSI) for tax refund

What is personal service income(PSI)

Income is classified as PSI when more than 50% of it comes from your personal efforts or skills, rather than assets, sales, or a business structure. To determine PSI, assess each contract – look at the terms, invoices, and agreements to calculate what percentage is for your labor vs. other factors. If 50% or less is from your individual efforts, none of that contract’s income is PSI.

example 1

Daniel, a sole trader plumber, receives a $250 contract for plumbing services. Of this, $225 is for his labor and $25 is for materials. Since over 50% ($225) is for his personal efforts and skills, this $250 income is classified as PSI

2

Tom, an IT consultant, provides services through her company SP Consulting. SP Consulting has a contract where over 50% of the payment is for Tom’s personal labor as a consultant. Therefore, even though the income goes to the company, it is classified as PSI for Tom

If you earn personal services income, you will need to withhold PAYG tax installments from the income at the top personal tax rate throughout the year. This is similar to having PAYG withholding applied if you are an employee.

You must report any personal services income and pay PAYG installments on your tax return each year. Failure to properly withhold and remit PAYG may result in penalties from the ATO.

What’s the difference between personal service income and sole trader income?

While personal service income and sole trader income may seem similar, there is an important distinction:

Personal service income refers to income earned by an individual for services performed through their own private company or business entity. The individual is essentially acting like an employee but using a company structure.

Sole trader income is income earned by an individual who operates their own unincorporated business as the sole owner. A sole trader reports their business income and expenses on their individual tax return.

The key differences are:

1. Personal service income rules look to identify situations where an individual is essentially an employee but using a private company to obtain a lower tax rate. Sole traders genuinely carry on a business on their own account.
2. Personal service income is taxed at the individual’s top marginal tax rate while still in the company. Sole trader income is taxed only after being drawn from the business as personal income.
3. Individuals earning personal service income may be subject to PAYG withholding obligations. Sole traders are not subject to these obligations on business income earned through their unincorporated business.

What’s the difference between personal service income and sole trader income?

If you have earned income that qualifies as personal services income, here are the steps to calculate the tax:

1. Determine your total personal services income for the financial year. This includes all income invoices issued for services performed through your business or company structure.
2. Calculate a reasonable estimate of deductions related to earning that personal services income. Allowable deductions include work-related expenses like travel, tools, subscriptions, uniforms and self-education.
3. Subtract the estimated deductions from your total personal services income to get your net personal services income amount.
4. Use the ATO’s tax rates and thresholds tables to identify your personal marginal tax rate based on your total taxable income for the year including the net personal services amount.
5. Multiply your net personal services income by your marginal tax rate as a percentage to calculate the amount of personal services income tax owing.

(For example, if your net personal services income is $80,000 and your marginal tax rate is 37%, the personal services income tax would be $80,000 x 37% = $29,600)

6. Add any other components of your taxable income and calculate your total tax payable.