ATO Personal Services Income (PSI) Rules 2026: Are You a Contractor or Employee?

New ATO guidance in 2026 tightens the PSI rules — if you're a sole trader contractor, this could mean the difference between claiming deductions and being treated like an employee.

By ECTD Editorial · Published 2026-07-06 · Updated 2026-07-06

If you're an Australian contractor earning income mainly from your personal skills or effort — whether you're a graphic designer, IT consultant, tradie, or management coach — the ATO's Personal Services Income (PSI) rules can seriously affect how much tax you pay and what deductions you can claim. In 2026, the ATO has updated its guidance, making it clearer than ever: just having an ABN doesn't mean you're running a business. Here's what you need to know.

What Is Personal Services Income (PSI)?

PSI is income that's mainly a reward for your personal efforts or skills. If more than 50% of the income you receive for a contract is for your personal work (not from using assets, hiring staff, or selling goods), it's PSI. The ATO looks at this on a per-contract basis, not across your whole year.

Common examples of PSI: a freelance web developer paid to build a site, a plumber hired to fix a leak, a management consultant delivering a strategy report. If the client is paying for *you* specifically — not for a business outcome — it's almost certainly PSI.

PSI doesn't just apply to contractors: Even if you operate through a company, trust, or partnership, the PSI rules can still apply. The ATO can 'look through' your entity and treat the income as if you earned it personally. This is called the PSI attribution rules.

The 80/20 Rule and the Results Test (2026 Update)

To avoid the PSI rules — and be treated as a genuine personal services business (PSB) — you need to pass one of four tests. The most common and important one is the **results test**. The ATO's 2026 guidance has clarified that to pass the results test, your contract must show all three of these elements:

You are paid to achieve a specific result or outcome, not for your time.
You are required to supply your own tools and equipment (or you bear the cost of them).
You are liable for the cost of rectifying any defective work (you carry commercial risk).

If you don't pass the results test, you can still try the unrelated clients test, employment test, or business premises test — but in practice, most contractors rely on the results test. The ATO's 2026 update emphasises that simply having an ABN, invoicing, and using your own laptop does *not* automatically pass the results test.

2026 ATO focus area: The ATO has flagged PSI as a compliance priority for 2026. They're using data matching to identify contractors who claim business deductions but haven't passed the results test. If you're audited and found to have incorrectly claimed deductions, you could face penalties and back-tax.

What Happens If You Don't Pass the Tests?

If your income is PSI and you don't meet any of the four tests to be a PSB, the ATO treats you like an employee for tax purposes — even though you're a contractor. This means:

You cannot claim deductions for rent, mortgage interest, home office costs, or payments to your spouse or associates.
You cannot claim travel expenses (e.g., driving to client sites).
You cannot claim phone or internet costs if they relate to your PSI work (unless you can prove they're directly incurred).
You cannot split income with family members through a trust or company structure.

Essentially, your deductions are limited to the same types an employee could claim — like work-related tools, training, and professional memberships. The ATO's view is that if you're not genuinely running a business, you shouldn't get business-level deductions.

How to Structure to Avoid PSI Issues

The safest way to avoid PSI problems is to genuinely run a business. That means:

Have multiple, unrelated clients (the ATO likes to see at least two or more).
Quote fixed prices for outcomes, not hourly or daily rates.
Use your own equipment, tools, and premises — and bear the cost of them.
Advertise your business, have a website, and operate under a business name.
Carry insurance and be liable for rectifying defects.

If you're a one-client contractor (common in IT and mining), you can still pass the results test if your contract is genuinely results-based. But many one-client contractors fail because their contract says 'we'll pay you $X per day for services' — that's a time-based arrangement, not a results test pass.

Review your contracts now: Before 30 June 2026, pull out your current client agreements. If they mention 'hours', 'days', or 'time spent', you're likely failing the results test. Consider renegotiating to a fixed-price outcome-based contract. The ATO will accept a genuine change in terms.

The 2026 Changes: What's New?

The ATO hasn't changed the law — the PSI rules are still in Division 85 of the ITAA 1997 — but they've released updated guidance (PCG 2026/D1) that clarifies:

The results test is now the primary test the ATO expects contractors to use.
The ATO has published a 'safe harbour' — if your contract meets a checklist of 7 criteria, they won't audit you on PSI for that contract.
The safe harbour criteria include having a written contract, quoting a fixed price, being liable for defects, and supplying your own tools.
If you don't meet the safe harbour, the ATO may still accept your position if you can demonstrate genuine business-like conduct.

The safe harbour is a big deal — it gives certainty. If you can tick all 7 boxes for a contract, you can sleep easy. If you can't, you need to be prepared to defend your position.

Practical Steps for 2025-26 Tax Return

Here's what to do right now:

Review every contract you have. For each, decide if it's PSI or not, and whether you pass the results test.
If you fail the results test, stop claiming business deductions that aren't available to employees. That includes home office, travel, and rent.
If you operate through a company or trust, consider whether the PSI attribution rules apply. If they do, the income must be attributed to you personally — you can't leave it in the company at the 25% tax rate.
Keep a log of your work activities, client communication, and contracts. The ATO can ask for these in an audit.
Talk to a registered tax agent who understands PSI. This is not a DIY area — mistakes are expensive.

ATO's PSI decision tool: The ATO has an online PSI decision tool on its website. It takes about 10 minutes to complete and gives you a written summary of where you stand. Use it before you lodge your 2025-26 return. It's free and doesn't trigger an audit.

The Bottom Line

The PSI rules are one of the most misunderstood areas of Australian tax law. In 2026, the ATO is making it a priority — and the days of 'she'll be right' contracting are over. If you earn income from your personal skills, take the time to understand whether you're a genuine business or a de facto employee. The tax difference can be tens of thousands of dollars — and the ATO is watching.

General information only — not personal financial, tax, legal or medical advice. Consider your own situation and consult a licensed professional before acting. Figures are current as at the date shown above.