Can I split my business income with my family?

I want to split my business income with my family – is income splitting allowed?

It’s a question we are asked regularly. Can I split my business income with my partner and family? And yes, we understand you want to reduce your tax liability. But in trying to reduce tax in this way, you may be breaching the Personal Services Income (PSI) rules which will put you right back where you started; and possibly with some ATO penalties thrown on top.

In this insight, we will provide some explanation of what is Personal Services Income (PSI) and its implications for your business.

Personal Services Income (PSI) rules are Australian tax laws aimed at income that individuals earn from providing personal services. These rules are crucial for understanding tax liabilities and deductions for both individual contractors and businesses that engage them.

Understanding PSI rules is not just beneficial but essential for tax compliance and financial well-being. Ignorance of these rules can have severe implications.

Understanding Personal Services Income (PSI)

Personal Services Income (PSI) is money you earn mainly from your personal skills or efforts as an individual. For example, if you’re a consultant, contractor, or freelancer, the income you get from your work is most likely considered to be PSI.

Why were PSI rules introduced?

The PSI rules were introduced to prevent people from reducing their tax by diverting their income to a company, trust, or partnership (known as a personal services entity or PSE) and splitting income to lower tax rate entities. The PSI rules are designed to stop you from diverting your earnings to another entity to pay less tax.

Can you split income?

When it comes to splitting income with your family, the PSI rules are quite strict. If your income is classified as PSI, you generally can’t split it with family members to reduce your tax bill. The income must be attributed to you personally, even if it’s paid to a company, trust, or partnership.

How do PSI rules work?

If you’re earning PSI, the rules ensure that income is treated like a regular salary. Here’s how it works:

• Attribution: The income is attributed to you personally, even if it’s paid to a company, trust, or partnership.
• Deductions: You can only claim deductions similar to those available to employees.
• PAYG Withholding: The entity receiving the income must withhold tax as if you were an employee.

PSI vs Business Income

Fortunately, not all income is classified as personal services income.

Business income is money earned from running a business where you’re selling goods or services that are not based solely on your skills. Understanding the difference is crucial for tax purposes. Business income can sometimes be split with family members, depending on the circumstances.

Personal Services Business (PSB)

To qualify as a Personal Services Business (PSB) you will need to meet certain tests. If you qualify as a PSB the PSI rules won’t apply to you. These tests include:

• Results Test: Are you being paid to achieve a specific result?
• Unrelated Clients Test: Do you have two or more clients who aren’t connected to each other?
• Employment Test: Do you have employees or subcontractors doing at least 20% of the work?
• Business Premises Test: Do you have a dedicated business location separate from your home?

If you meet these tests, your income might be considered business income rather than PSI, which could offer more flexibility in income splitting.

If you believe you meet these tests, you can apply to the ATO for a PSB determination. This helps ensure you’re not subject to the PSI rules and might allow you to split your income more freely.

What about deductions?

Here’s what you need to know about deductions:

• For Individuals: You can only claim deductions similar to those available to employees.
• For a Personal Services Business: You can claim some costs incurred by the entity, but there are limits.

Key points to remember

1. Stay Compliant: Make sure you understand whether your income is PSI or business income.
2. Seek Professional Advice: A good accountant or tax agent can help you navigate these rules and ensure you’re compliant.
3. Keep Accurate Records: Keeping your accounting records up to date will make it easier to stay on top of your tax obligations.

Final thoughts

While it might be tempting to split your income with family members to save on taxes, the PSI rules make this challenging . However, understanding whether your income is PSI or business income, and knowing the tests for a PSB, can help you find the best approach for your situation. Always seek professional advice to ensure you’re making the right decisions for your business.

These rules can be daunting, so it’s important to get professional advice and make sure you are staying compliant. Get in touch if you have questions.