Published on 21 Jan 2026
How PSI Affects Your Bookkeeping and Tax Obligations as a Small Business Owner depends on whether your income is treated as Personal Services Income (PSI) or as ordinary business income. When most of the income received is a reward for your personal efforts or personal skills, special rules can apply and change what you report and what you can claim. Understanding when PSI rules apply helps you avoid lost tax deductions, incorrect tax returns and unexpected tax bills.
For many small business owners and sole trader contractors, this is not just theory – PSI can directly affect how much tax you pay and the way you need to keep your records. The Australian Taxation Office has clear PSI rules to stop people using a business structure only to gain a tax benefit that would not be available to an employee. When you know where you stand, you can earn PSI confidently, pay tax correctly and keep your bookkeeping simple and consistent.
What Is Personal Services Income for Small Business Owners?
Personal Services Income is income where more than half of the income produced is mainly a reward for your personal efforts or skills. In other words, the client is paying you for what you do as an individual, not mainly for an income producing asset or large business operation. This can affect both your tax obligations and the deductions you can claim.
PSI can arise in almost any industry where you personally provide services, including construction workers, information technology consultants, designers, coaches and medical practitioners. If the income received is closely tied to the work you personally perform, there is a good chance you earn PSI and may need to self-assess whether PSI rules apply each income year.
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How Do You Test Whether PSI Rules Apply to your Business?
To test whether PSI rules apply, you first work out if you earn PSI at all, then check whether you qualify as a personal services business. You look at each contract or client and ask whether more than 50% of the amount paid is for your personal efforts or skills rather than for the use of a substantial asset or other staff. If you earn PSI, you then apply the personal services business tests.
A personal services business can exist where you pass the results test, unrelated clients test, employment test or business premises test, or where you obtain a personal services business determination from the Australian Taxation Office. If you cannot pass any PSB tests and do not have a PSB determination, the special rules apply to that PSI income and may restrict certain deductions and how you report PSI in your tax return.
How Do the PSI Rules Affect Your Tax Obligations?
When PSI rules apply, the Australian Taxation Office can treat the PSI amounts as if they were earned directly by the individual who does the work, even if the income flows through a company or trust. This means the income is taxed at the individual tax rate and the tax consequences may be similar to an employee. In many cases, special rules prevent you from using a business structure solely to gain a tax benefit.
The PSI rules can limit certain deductions and change how you calculate your taxable income. You may not be able to claim deductions that relate more to a wider business rather than to the services income you generate personally. The aim is that people who provide services and earn PSI pay tax in line with others doing similar work, not at a lower rate simply because they use a different structure.
Tax Areas Most Commonly Affected By PSI
How much taxable income is attributed back to you personally from a personal services entity.
Whether you can split PSI income with family members through wages or distributions.
Which deductions you can claim as business expenses versus personal or private costs.
How Does PSI Change the Way You Keep Your Books?
When you generate PSI, your bookkeeping needs to clearly show which income and expenses relate to your personal services, and which relate to other activities. Good records make it easier to test individual’s PSI each year, apply the PSB tests and prepare an accurate income tax return. Clear coding also helps you show the Australian Taxation Office that you understand and apply the rules correctly.
You may need separate accounts for PSI income, other business income and expenses that could be affected by PSI rules. It is also important to keep contracts, invoices, records of marketing to more than one client and details of any business premises you use, so you can support an unrelated clients test or business premises test if needed. Strong bookkeeping gives you evidence, not just assumptions, if unusual circumstances prevented normal operations or you need further guidance.
What Deductions Can You Claim When PSI Rules Apply?
Where PSI rules apply, you can generally only claim deductions you can claim if you were in a similar role as an employee. You may still claim deductions for expenses that directly relate to earning PSI, such as work‑related travel, phone and a portion of running costs that are clearly connected to the services income. However, certain deductions linked to a wider business structure may be restricted.
For example, you usually cannot claim deductions for rent, interest or rates on a home that is mainly used as your residence rather than as separate business premises. Wages paid to family members may also be limited if the dominant purpose is to share PSI income rather than pay for real principal work done at commercial rates. Understanding the deductions you can claim and those that are considered certain deductions not allowed under PSI is essential.
How Do You Report PSI In Your Tax Return or Business Return?
If you are a sole trader, you generally report PSI received in the business schedule of your individual tax return. You will need to report PSI amounts at the relevant labels and disclose any adjustments where PSI rules apply and limit your deductions. It is important that you correctly identify PSI and not mix it with other business income when you report PSI.
If you use a company or trust as a personal services entity, that same entity usually needs to show PSI in its tax return too. In many cases, PSI income is then attributed back to you as the individual so that the income tax is paid at your rate, not another lower rate inside the entity. Getting this wrong can affect your taxable income, lead to amendments and increase your risk of review.
How Do the PSB Tests Work in Real‑Life Situations?
In practice, passing one of the PSB tests can mean that the special rules do not apply to that PSI, as long as the conditions are genuinely met. Under the results test, you are usually paid to achieve a specific result and you are responsible for fixing any defects in the work. Under the unrelated clients test, you need to have more than one client and obtain those clients through public offers or marketing, not just through a single labour hire arrangement.
The employment test and business premises test look more at the structure of your business. If more than one individual performs the principal work, or if you have employees or apprentices doing a significant portion of the work, this can support PSB status. Likewise, using separate business premises that are mainly used to provide services to clients, and not shared with another business, can show you operate more than a simple one‑person operation.
How Can PSI Affect Different Types of Small Businesses?
PSI can affect many different business types where the core offering is personal services. A sole trader consultant who provides services directly to one client for most of the year may find that PSI rules apply and that they cannot access certain deductions they expected. An information technology consultant operating through a company might find that wages and distributions still need to reflect that the company is mainly a personal services entity.
Construction workers who contract to one builder and medical practitioners who contract to a clinic can also generate PSI if their income is linked mainly to their personal efforts. In these cases, the PSI rules, PSB tests and any PSB determination can influence how much tax they pay, how much income can be retained in the business and which deductions are allowed. Recognising PSI early allows these businesses to choose a business structure and bookkeeping approach that supports clear, compliant reporting.
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How Does Recent ATO Guidance Affect PSI Arrangements?
Even where your business passes the PSB tests, the ATO can still review income‑splitting arrangements under Part IVA anti‑avoidance rules. On 1 December 2025, the ATO released Practical Compliance Guideline PCG 2025/5, which clarifies that passing a PSB test does not automatically protect you from scrutiny if PSI is diverted or retained mainly to reduce tax.
PCG 2025/5 outlines low‑risk and higher‑risk arrangements based on how PSI is distributed and retained. Low‑risk arrangements include where net PSI is paid to the individual who performed the services and taxed at their marginal rate, or where profit retention has clear commercial purposes with documented evidence. Higher‑risk arrangements include splitting PSI with family members on lower tax rates, retaining profits beyond genuine business needs, or paying the individual less than the commercial value of their services.
What This Means for Your Business
Businesses with higher‑risk arrangements have until 30 June 2027 to restructure into low‑risk models.
Restructuring by this deadline reduces the likelihood of Part IVA reviews for prior years.
Clear documentation of commercial decisions and reasons for profit retention is now more important than ever.
When Should You Seek Professional Advice on PSI?
Because PSI interacts with both tax law and practical bookkeeping, it is an area where professional advice can add real value. If you are unsure whether you earn PSI, whether PSI rules apply, or whether your business passes any PSB tests, it is wise to seek professional advice rather than guessing. Getting it right early can prevent problems and help you plan your tax obligations with confidence.
You should also seek professional advice if you are considering changing your business structure, paying wages to family members, or if your income pattern has shifted to one client or one main contract. A tax adviser or experienced bookkeeper can help you self-assess your position, explain how PSI may affect the deductions you can claim and guide you on any further guidance from the Australian Taxation Office. Our team can review your PSI position, your bookkeeping and your tax return approach so you can focus on running your business while we look after the details.
