Contractor vs Employee Tax: What Actually Changes

Same tax brackets, different collection

The most common misconception is that contractors pay a different tax rate. They don't. Both employees and contractors pay income tax on the same progressive scale — the 2025-26 brackets are identical regardless of how you earn the income.

What changes is how the tax is collected and what else you're responsible for:

• Employees have tax withheld from each pay cycle by their employer (PAYG withholding). Your employer also handles super, workers' comp, and payroll tax.
• Contractors receive the full invoice amount (plus GST if registered) and are responsible for setting aside their own tax, paying it in quarterly PAYG instalments, and managing their own super contributions.

Obligations at a glance

Here's a side-by-side view of what each arrangement requires:

GST: the $75,000 threshold

As a contractor, you must register for GST if your GST turnover (gross business income, not profit) reaches $75,000 or more in any rolling 12-month period. Once registered:

• You charge 10% GST on top of your invoices. A $1,000 invoice becomes $1,100.
• You can claim GST credits on business purchases — equipment, software, insurance premiums, even accounting fees.
• You remit the net GST (collected minus credits) to the ATO each quarter via your BAS.

Should you register voluntarily below $75K?

If your turnover is under $75,000, registration is optional. It can be worth it if you have significant business expenses with GST (equipment, software subscriptions, vehicle costs) because you can claim those GST credits back. But if you mostly sell your time and have few expenses, registration adds paperwork for little benefit — and makes your invoices 10% more expensive for clients who aren't GST-registered themselves.

Superannuation: who pays?

This is where the financial gap between employees and contractors really shows.

Employees

Your employer pays 12% SG (Superannuation Guarantee) on top of your salary in 2025-26. If you earn $100,000, your employer contributes $12,000 to your super fund — this is in addition to your gross salary, not deducted from it.

Contractors

If you're a genuinely independent contractor, nobody pays your super. You need to fund it yourself. The good news: voluntary super contributions up to the $30,000 concessional cap are tax-deductible and taxed at just 15% inside super (or 30% if your income exceeds $250,000 under Division 293).

Leave and entitlements

Under the National Employment Standards (NES), full-time employees are entitled to paid leave that contractors simply don't get. The cost of self-funding equivalent time off is one of the biggest hidden expenses of contracting.

Put simply: a contractor taking the same amount of time off as an employee is working about 46 weeks per year instead of 52. Every week off is a week without income.

Business deductions contractors can claim

Contractors can claim a much wider range of deductions than employees, because expenses incurred in running a business are deductible. The key categories:

Home office

If you work from home, you can claim running expenses using the fixed rate of 70 cents per hour (covering energy, phone, internet, and stationery) or the actual cost method. On top of either method, you can separately claim depreciation on office furniture and equipment. If you have a dedicated home office, you may also be able to claim a portion of rent, mortgage interest, or house insurance as occupancy expenses — but this has capital gains tax implications if you own your home.

Vehicle and travel

Unlike employees (who can't claim the commute), contractors who travel between clients or to project sites can claim travel as a business expense. Options include the 88 cents per km method (up to 5,000 km) or the logbook method for actual costs including fuel, insurance, registration, and depreciation.

Equipment and tools

Items under $300 used mainly for work are immediately deductible. Items over $300 are depreciated over their effective life (e.g., 4 years for laptops). Small businesses with turnover under $10 million can use the instant asset write-off for eligible assets.

Professional development

Courses, certifications, conferences, and textbooks directly related to your current business activities are deductible. Unlike employees, contractors don't need to show the training maintains or improves skills for a specific employer — it just needs to relate to your current business.

Insurance premiums

Public liability, professional indemnity, and income protection insurance premiums are all deductible business expenses. So are accounting and legal fees, software subscriptions, and phone and internet costs attributable to business use.

BAS and PAYG instalments

As a contractor, you'll deal with the Business Activity Statement (BAS) — the quarterly form where you report GST and PAYG instalments. This is administration that employees never have to think about.

What goes on a BAS?

• GST collected on your invoices minus GST credits on business purchases (if GST-registered)
• PAYG instalments — quarterly pre-payments of your expected income tax. The ATO calculates these based on your last tax return and sends you an instalment rate or amount.

2025-26 quarterly due dates

If you use a registered BAS agent, you typically get a 4-week extension. Late lodgement attracts Failure-to-Lodge penalties starting at $313 per 28-day period overdue, up to a maximum of $1,565 per BAS. Late payment incurs the General Interest Charge (GIC) at approximately 11.17% per annum, compounding daily.

Insurance you need as a contractor

Employees are covered by their employer's workers' compensation and public liability insurance. Contractors need their own policies. The main types:

Many clients and head contractors require proof of public liability and professional indemnity insurance before engaging you. Income protection is optional but strongly recommended — as a sole trader, one injury or illness means zero income until you're back at work. All insurance premiums are tax-deductible business expenses.

The break-even rate: worked example

Here's a practical comparison for someone choosing between a $100,000 employee salary and contracting. We'll calculate the hourly rate a contractor needs to charge to match the employee's total compensation.

Step 1: True employee compensation

Step 2: Contractor billable hours

A contractor taking 4 weeks holiday, 2 weeks sick, and losing 8 public holidays works about 44 weeks per year. At 40 hours per week, that's roughly 1,760 billable hours. In practice, you also lose time to admin (invoicing, BAS, chasing payments), so realistic billable hours are closer to 1,600-1,700.

Step 3: The contractor's costs

Step 4: Break-even rate

To match the employee's $100,000 salary after covering all contractor costs, you need to gross at least $119,000 ($100,000 + $19,000 in costs). Spread over 1,700 billable hours:

$119,000 ÷ 1,700 hours = ~$70/hour (excl. GST)

This doesn't account for the employer super the employee receives on top ($12,000) or leave loading. To truly match the full $128,115 package:

$128,115 ÷ 1,700 hours = ~$75/hour (excl. GST)

Employee or contractor? The legal test

Whether you're an employee or contractor isn't something you can simply choose. The legal classification depends on the nature of the working relationship, and getting it wrong has real consequences.

The contract-first approach (tax law)

Following the High Court decisions in CFMMEU v Personnel Contracting (2022) and ZG Operations v Jamsek (2022), the ATO primarily looks at the written contract to determine whether a worker is an employee or contractor for tax purposes. If the contract is comprehensive and genuine, the terms of the contract — not how the relationship plays out in practice — determine the classification.

The whole-of-relationship test (Fair Work)

For employment law purposes (under the Fair Work Act, from 26 August 2024), the test is different. The "whole of relationship" test looks at how the arrangement actually operates in practice, not just what the contract says. This means a worker could be classified as a contractor for tax but an employee for Fair Work purposes, or vice versa.

Key factors in the classification

Sham contracting and ATO enforcement

"Sham contracting" is when a business treats a worker as a contractor to avoid paying super, leave, and other entitlements — when the true nature of the relationship is employment. It's illegal under both the Fair Work Act and tax law.

Consequences for businesses

• Back-payment of super — the full SG amount for the entire engagement, plus interest via the Superannuation Guarantee Charge (SGC)
• PAYG withholding obligations — the business becomes liable for all the tax that should have been withheld
• Fair Work penalties — up to $18,780 per contravention for individuals and $93,900 for companies (2025-26 rates)
• Payroll tax and workers' comp — state revenue offices can also pursue unpaid payroll tax and workers' compensation premiums

Industries under scrutiny

The ATO and Fair Work Ombudsman have flagged several industries for active enforcement around contractor classification: IT and software development, building and construction, healthcare and allied health, cleaning, courier and delivery services, and the gig economy. If you work in these sectors, make sure your arrangement genuinely reflects an independent contractor relationship.

Quick reference: key numbers for 2025-26