Professional services firms face a different set of challenges as they grow. As income increases and structures evolve, the complexity often sits behind the scenes: how income is derived, how profits are distributed, and how the business is structured from a tax and compliance perspective. Getting this right creates clarity and provides a platform not just for the business itself, but for wider wealth creation over time.

One common (and often misunderstood) challenge is successfully navigating the ‘PSI rules’.

Most professionals have heard their accountant mention concepts like “personal services income”, “PSB status”, or whether income can be split, retained, or distributed more flexibly. The difficulty is that these rules are frequently misapplied – sometimes in completely opposite ways. Some advisers are still influenced by how professional firms operated years ago, before the current PSI and professional firm profit allocation frameworks were properly embedded. Others take an overly cautious view, assuming the rules apply more broadly than they do in practice, which can result in unnecessary tax, rigid structures, and lost planning opportunities.

Income Splitting & Profit Retention

At its core, income splitting (and profit retention) is about who is taxed on income, when, and at what tax rate. The further you move away from pure employment-style income, the more flexibility the tax system allows, but only where that flexibility is commercially justified.

Think of it as a spectrum. At one end is employment-like income, where the ATO expects income to be taxed almost entirely in the hands of the individual doing the work. There’s little to no scope to divert, retain, or split that income without triggering risk. At the other end are businesses generating returns from systems, staff, capital, or assets, where profits can be retained, distributed across family members and other entities, or reinvested over time.

Why does this matter? Because splitting or retaining profits can:

• Smooth cash flow and tax outcomes year to year

• Allow surplus profits to be reinvested into growth or investments without losing half to income tax

• Support asset protection and long-term wealth strategies

Most professional firms sit somewhere in the middle. They aren’t pure employment, but they also aren’t capital-heavy businesses. The challenge (and opportunity) is understanding where your income genuinely sits on this spectrum, and structuring accordingly. That’s where PSI, PSB status, and the professional firm profit rules come into play.

This becomes increasingly important once business profits push beyond the $190k range, where the top personal tax rate of 47% applies.

What is Personal Services Income (PSI)?

Personal Services Income (PSI) is income that is mainly a reward for an individual’s personal skills, knowledge, effort or expertise. Critically, PSI is determined by the nature of the income, not the structure used to earn it. You can earn PSI through a sole trader, company, or trust (often referred to as a Personal Services Entity, or PSE). Where PSI applies, the tax law limits how that income can be split, retained, or diverted away from the individual who performed the work.

By contrast, where income is generated by a genuine business structure – involving staff, systems, significant assets, multiple income sources, or capital - profits are treated as business income and can generally be retained or distributed more flexibly.

Determining which type of income you’re generating is just the starting point. From there, the analysis shifts to how the ATO expects that income to be taxed, allocated, and supported in practice.

What type of income are you generating?

How we can help your firm.

In reality, this is rarely a simple yes-or-no exercise. Our role is to step back and look at how your income is generated and where you sit on the ATO’s risk spectrum. For some clients, that means working through the PSI and PSB tests properly and ensuring any structure used is technically sound and defensible. For others, it means designing profit allocation and structuring arrangements that reflect commercial reality and support longer-term wealth creation.

This is an area where experience matters. Accountants who don’t truly understand these rules often fall into one of two camps: they’re overly cautious and leave clients paying more tax than necessary, or they take positions that aren’t well supported and expose clients to substantial risk.

Our focus is to get the best possible tax outcome within an acceptable risk framework, so profits can be retained, reinvested, and compounded over time, all without unpleasant surprises down the track.