Those in the know often receive larger tax returns because they know what and how they can claim on certain work expenses. After all they’ve learned a dollar back in your pocket is much better than in the government’s coffers. Different professions offer a range of tax deductions that aren’t applicable for others, but when it comes to claiming expenses on your tax, a big decider is if you’re classed as an employee or a contractor.
What’s The Big Difference?
The main difference between an employee and contactor is that an employee works for a business and is a part of the business, and a contractor runs their own business.
An employee can’t delegate the job they are given to do by their employer. They’ve been employed to do a task, and they are the individual who must do the job. They cannot outsource their own job. A contactor may do those things. They can delegate out work as well as outsource the jobs they manage.
An employee is paid for their time as an hourly rate, to produce an item, or as a commission for work done. A contactor is paid to achieve a certain result based on a quote to achieve the result.
An employee uses tools of trade supplied by the employer, or if they use their own tools, an employee is reimbursed or paid an allowance for the cost of the tools. A contractor provides their own tools to complete the work and is not compensated for the cost of tools required to do the job.
The business is legally responsible for the work produced by the employee. If something goes wrong, the employee’s business is responsible for rectifying the mistake. Contactors are legally responsible for their own work and if something goes wrong, they are responsible for rectifying the mistake at their own cost.
The business the employee works for directs the outcome of the work. The employee has no say in the direction of their work. A contractor has freedom in the way in which the work is done and what is produced, subject to terms of the agreement.
An employee does not work independently from the business that employs them. They are seen as an extension of the business. A contractor is an independent operator who works from the agreement made in the quote. They are free to take on or decline more work.
Tax and Super Obligations
Tax, superannuation and other obligations vary for both employees and contractors. Employees have tax withdrawn from their salary or wage by their employer with each pay period. The employer is responsible for paying the Australian Taxation Office (ATO) on their behalf. An employer will also pay their employees’ super into their nominated funds with each pay period. Both income tax and super obligations are paid using Single Touch Payroll (STP) which notifies the ATO in real time.
Contractors are responsible for paying their own income tax and superannuation (unless employed primarily for labour). A contractor is not required to notify the ATO of tax and super payments made through STP or in any other way for themselves. A voluntary agreement to have withholding applied can be made between the employer and contractor if applicable. A business does not need to provide a payment summary if they hire a contractor. If you’re a contractor, you should be aware of several responsibilities.
Because contactors are not employees, they are not protected by a business’s insurance if they are in an accident or unable to work through sickness or injury. A contactor is responsible for organising their own insurances, should there come a time they’re needed.
Two such insurances are liability insurance that covers damages and injuries caused to other people in performing a job, and asset and revenue insurance which protects loss, theft or damage of assets. Work cover and income insurance should also be taken to protect a contractor should something happen to prevent them from being able to work or earn an income.
Depending on the industry, a contactor might need certain licenses to perform their job, for example electrical licenses for an electrician.
As a contractor, you may be entitled to receive super payments from an employer. If a contractor is employed for their labour, the ATO considers them to be an employee for super purposes. As such, as contractor is entitled to be paid super under the same rules as employees. If you’re not entitled to super payments, you should consider opening your own fund and making payments.
Tax File Number
If you’re operating as a sole trader, partnership or registered company, you’ll need a Tax File Number (TFN). Without a TFN you’ll be obligated to pay the highest marginal tax rate of 45% plus 2% Medicare levy.
Australian Business Number
If a contractor doesn’t have an ABN, an employer is legally bound to withhold the top marginal tax rate, plus the Medicare Levy from a payment. Labour hire workers aren’t entitled to an ABN. Check if you’re entitled before applying.
Goods and Services Tax
The Goods and Services tax (GST) must be collected and paid when a business earns over $75,000 aggregated turnover per annum. (If you offer a ride-sourcing service, you’ll need to register for GST regardless of turnover). Contractors can claim GST input credits for their business if they are registered for GST.
Personal Services Income
Some contractors may be considered to earn an income known as Personal Services Income (PSI) for their skills or efforts as an individual. Income should be worked out from each separate contract or invoice to determine tax and super obligations. Special tax rules may apply as well as tax deductions that can be made.
Pay As You Go
Pay As You Go (PAYG) instalments will help a contractor keep on top of their income tax obligations. They are regular payments paid to the ATO which count towards a contractor’s annual obligations. Payments are generally made by contractors who earn a certain income amount. The ATO will notify contractors should they need to make PAYG instalments.
Tax Deductions for Contractors
There are a range of tax deductions that can be made if you’re a contractor: operating expenses (these expenses can be claim in the year they incur), and capital expenses (these may be expensed over a period of years.) For the best results when it comes to claiming all applicable tax deductions, a chat with a tax professional can save you hundreds, if not thousands of dollars. If you’re not sure if you’re an employee or a contractor a chat with an ITP tax professional can help clear up any confusion. Phone 1800 367 487 and chat with a professional today.