Working as a subcontractor does not automatically mean you pay more tax than an employee. However, it can certainly feel that way when no tax is withheld from your invoices, you are responsible for your own expenses, and you need to manage GST, BAS lodgments and superannuation yourself.
The real question is not whether subcontractors are taxed more. It is whether your business income, deductions, structure and record-keeping are being managed properly. With the right approach, you can claim what you are genuinely entitled to, avoid costly surprises and make more confident decisions throughout the year.
Why subcontractors can feel like they pay more tax
Employees usually have PAYG withholding taken from each pay. A subcontractor may receive the full invoice amount, then face an income tax bill later after lodging their return. That difference is often a cashflow issue rather than proof that the subcontractor has been taxed at a higher rate.
As a sole trader, you generally report your business income and allowable business expenses in your individual tax return. Tax is calculated on your taxable income, not simply on the total amount you invoiced.
Subcontractors can also face costs that employees may not pay directly, such as:
– Public liability, professional indemnity or income protection insurance
– Tools, equipment and consumable materials
– Vehicle running costs and travel between work sites
– Bookkeeping software, accounting fees and bank charges
– Licences, registrations, professional memberships and training
– Mobile phone, internet and home office costs
– Superannuation contributions
These costs can be deductible where they are sufficiently connected to earning income or running the business. But they still need to be real expenses, properly apportioned where there is private use, and supported by records.
It is also worth remembering that calling someone a “contractor” does not settle their legal status. The actual rights and obligations under the arrangement matter. A written agreement, how the work is arranged, the ability to delegate, control over the work and whether the worker is engaged to achieve a result can all be relevant.
Seven smart ways to reduce your tax bill legitimately
1. Check whether the personal services income rules apply
Many subcontractors earn income mainly from their own personal efforts, skills or expertise. This may be personal services income, often called PSI.
PSI is common for consultants, tradespeople, IT contractors, project managers, designers, labour-hire workers and many other service providers. It can be earned as a sole trader or through a company, trust or partnership.
The PSI rules are designed to prevent people from using an entity simply to divert income generated by their own work to another person or to defer tax. If the rules apply, deductions can be restricted and income splitting through a company or trust may not achieve the intended result.
This does not mean every contractor is caught by the PSI rules. A contractor may be conducting a genuine personal services business if they meet the relevant tests or hold a determination. The answer depends on the facts, including how clients are obtained, the nature of the contracts, whether the work is results-based and the extent to which others perform the principal work.
Before setting up a company or trust for tax reasons, have the PSI position reviewed. A structure can still be useful for commercial, asset protection or growth reasons, but it should not be adopted on the assumption that it will automatically reduce tax.
2. Claim all legitimate business expenses, not just the obvious ones
The basic tax principle is that an expense must be incurred in earning assessable income or in carrying on a business for that purpose. Private, domestic and capital expenses are generally not immediately deductible in full.
For subcontractors, commonly overlooked deductible expenses can include:
– Accounting and tax agent fees
– Bookkeeping and invoicing software
– Merchant fees and business bank charges
– Advertising, website hosting and lead-generation costs
– Business insurance premiums
– Industry licences, permits and registrations
– Protective clothing and safety equipment where appropriate
– Trade-specific tools, repairs and consumable materials
– Phone and internet costs to the business-use extent
– Professional memberships, trade publications and qualifying training
– Costs of managing tax affairs
The key is to claim the business portion only. If a mobile phone, internet plan, vehicle or computer is used privately as well as for work, you need a reasonable basis for separating the business use from personal use.
Do not assume that an expense is deductible merely because it feels work-related. For example, ordinary clothing, private travel, meals of a private nature and expenses reimbursed by a client generally require careful consideration before being claimed.
3. Keep clean records and account properly for vehicles, tools and equipment
Good record-keeping is one of the most practical tax-saving habits a subcontractor can develop. It helps you identify deductions during the year rather than relying on memory at tax time, and it provides evidence if the ATO asks questions later.
Keep copies of:
– Tax invoices and receipts
– Bank and credit card statements
– Supplier contracts and client agreements
– Vehicle records, including logbooks where relevant
– Diaries or spreadsheets supporting phone, internet and home office claims
– Asset purchase documents and disposal records
– GST and BAS records
– Superannuation contribution confirmations
Most tax records need to be retained for a significant period, and records for assets, losses and capital gains tax matters may need to be kept longer. Electronic records are acceptable if they are complete, accessible and protected from alteration.
Tools, machinery, computers and other equipment can require special treatment. Some items may be immediately deductible under the rules available for the relevant year, while others may need to be claimed over time as they decline in value. The treatment depends on the asset, its cost, its business use and the rules applying to your entity.
Vehicles also need care. A contractor who drives from home to a regular work location may not necessarily be able to claim that trip, while travel between work sites, to suppliers or to temporary jobs may be treated differently. Keep contemporaneous records rather than estimating kilometres after the fact.
4. Manage GST separately from income tax
GST and income tax are different systems, but they affect the same bank account. Confusing them is one of the fastest ways for a subcontractor to run short of cash.
If your GST turnover reaches the registration threshold, you may need to register for GST. Once registered, you generally charge GST on taxable sales, lodge BAS statements and may be entitled to claim GST credits for eligible business purchases.
A useful practical rule is to treat GST collected from clients as money that does not belong to your business. Set it aside as invoices are paid rather than waiting for the BAS due date.
If you are registered for GST, remember that the GST component of an eligible purchase may be claimed through the BAS as a GST credit. This generally means you do not also claim that same GST amount as part of your income tax deduction.
For example, a subcontractor who buys work materials from a GST-registered supplier may be able to claim the GST credit through their BAS, provided the purchase is creditable and they hold the required documentation. Their income tax deduction is then generally based on the net business cost.
5. Use superannuation as part of your tax planning, not an afterthought
Employees usually receive compulsory superannuation contributions from their employer. Subcontractors need to take a more active role in building retirement savings.
Depending on the arrangement, a business engaging an individual contractor may still have superannuation guarantee obligations, particularly where the contract is mainly for that person’s labour and skills. Having an ABN or issuing invoices does not automatically remove this possibility.
If you are genuinely self-employed and no one is contributing super for you, personal deductible super contributions may be worth considering. Subject to eligibility requirements and contribution caps, a personal contribution may be claimed as a tax deduction.
There are important steps to get right:
– The contribution must be received by the super fund within the relevant timeframe.
– You need to be eligible to claim the deduction.
– You must give your super fund a valid notice of intent to claim a deduction.
– Your fund must acknowledge that notice before you claim the deduction in your tax return.
– Your total concessional contributions need to remain within the applicable cap, taking into account any employer or other concessional contributions.
A deductible super contribution can reduce taxable income, but it also moves money into superannuation, where access is generally restricted until a condition of release is met. It is a tax and retirement-planning decision, not simply a last-minute deduction.
6. Review your business structure before growth makes it harder to change
Many subcontractors begin as sole traders because the structure is straightforward and inexpensive to operate. That can be entirely appropriate, especially when income is modest, work is personal in nature and the business is still being tested.
As income grows, you may consider whether a company, trust or partnership is commercially appropriate. The right structure can assist with administration, ownership arrangements, bringing in other workers, asset protection considerations and long-term growth.
However, structure should not be chosen solely because someone says it will “save tax”. Companies and trusts involve additional compliance, accounting and legal obligations. Money taken from a company must also be managed correctly, and there can be significant tax consequences if company funds are treated as personal funds.
Most importantly, a company or trust does not override the PSI rules. If income is mainly generated by one individual’s personal efforts and the rules apply, that income may still be attributed to that individual.
A structure review is most useful before signing major contracts, employing staff, purchasing significant assets or bringing in a spouse, business partner or investor.
7. Forecast your tax position before EOFY
The best time to manage tax is throughout the year, not when your accountant asks for records after 30 June.
A simple quarterly review can help you estimate:
– Income received and invoices still outstanding
– Business expenses paid or incurred
– GST collected and GST credits available
– Superannuation contributions made
– PAYG instalments already paid
– Whether your current cash reserve is likely to cover tax obligations
If your income has increased, you may need to increase the amount set aside for income tax. If income has fallen, or your circumstances have changed materially, there may be scope to review PAYG instalments rather than continuing with an amount that no longer reflects your expected tax position.
Before EOFY, consider whether there are genuine business expenses you already need to incur, whether depreciating assets require review and whether a personal super contribution suits your broader financial position. Avoid spending money simply to obtain a deduction. A deduction may reduce tax, but you are still paying for the underlying expense.
A practical subcontractor scenario
Consider a sole trader electrician who invoices several builders during the year. They have regular income, use their own vehicle and tools, pay for insurance and software, and contribute to their own superannuation.
At tax time, they initially focus only on their invoices and fuel receipts. After reviewing their records, they also identify eligible costs for insurance, licensing, accounting, phone use, safety equipment, tool repairs and bookkeeping software. They have kept a proper vehicle record and can identify the business-use portion of relevant costs.
They also discover that GST collected from clients has been mixed into their everyday account, making their BAS liability feel like an unexpected expense. By opening a separate savings account for GST and income tax going forward, they improve cashflow and reduce the risk of an unwelcome bill.
The result is not a manufactured deduction or aggressive scheme. It is simply accurate reporting, better records and tax planning based on the way the business actually operates.
Avoid shortcuts that create bigger problems
Be cautious of advice that sounds too simple, particularly claims that contractors can automatically deduct everything, split all income with family members or run personal spending through a company.
Common problem areas include:
– Claiming private expenses as business deductions
– Estimating vehicle or phone claims without records
– Treating GST collected as business income available to spend
– Forgetting to report cash income
– Paying family members without considering the work performed and the PSI rules
– Using company money personally without proper documentation
– Ignoring PAYG instalments until a large tax debt arises
– Assuming a contract label determines whether someone is an employee or contractor
The safest tax strategy is usually the least dramatic one: report all income, claim only supportable deductions, keep records as you go and obtain advice before making structural or large financial decisions.
The key takeaway
Subcontractors do not necessarily pay more tax than employees, but they do have more responsibility for managing it. The biggest opportunities usually come from claiming legitimate business expenses, separating GST and tax cashflow, planning superannuation contributions, understanding PSI and choosing a structure that suits the real business.
Every subcontracting arrangement is different. Ample Finance can help you review your deductions, GST obligations, superannuation strategy and business structure in the context of your own circumstances.
This article is general information only and is not personal financial or tax advice. Tax outcomes depend on your individual circumstances, so speak with a registered tax agent or accountant, such as Ample Finance, before acting on any tax strategy.