Paying tax once a year can leave a sole trader with a large bill. PAYG instalments spread that tax across the year instead. Many small business owners are placed into the system after a good year. Others choose to join early so the tax bill does not come as a shock.
This guide explains what PAYG instalments are and who has to pay them. It also covers the two ways to work out each payment and how to change them. The details come from the Australian Taxation Office. Tax rules change, so check current guidance before acting.
What PAYG instalments are
The ATO describes PAYG instalments as regular prepayments of the expected tax on your business and investment income. They are usually paid every quarter. When you lodge your tax return, the instalments you paid are offset against your tax. That usually leaves little or no tax to pay at the end of the year.
PAYG instalments are different from PAYG withholding. Withholding is tax an employer takes out of employee pay and sends to the ATO. Instalments are payments of your own income tax. A business with staff may deal with both, so it helps to keep them separate in the books.
Who has to pay
The ATO enters people into the system automatically when their latest tax return shows income above certain levels. The ATO page on starting PAYG instalments sets out the tests. For individuals, including sole traders, and for trusts, all three tests must apply. Instalment income from the latest return must be $4,000 or more, tax payable on the latest notice of assessment $1,000 or more and estimated notional tax $500 or more.
Companies follow different rules. A company enters if any one of several tests applies. These include instalment income of $2 million or more on its latest return, or estimated notional tax of $500 or more. The head company of a consolidated group also enters and pays for the group as one entity.
Business structure therefore affects which tests apply. Owners still deciding can read about choosing a sole trader or company structure for a new business. The choice affects much more than tax, so it is worth getting advice. Once the structure is set, the instalment rules for that type of entity follow.
Joining voluntarily
You do not have to wait for the ATO to enter you. Business.gov.au explains that you can ask to enter the PAYG instalments system. Sole traders can do this online through myGov, or a registered tax or BAS agent can do it for you. This can suit a new business that expects to make a profit.
Joining early means putting money aside through the year rather than all at once. It can make cash flow easier to plan. A new business has plenty of other early tasks, such as registering for an ABN, which is covered in the basic legal practicalities of starting a landscaping business. Adding tax planning to that list early saves stress later.
Instalment amount or instalment rate
The ATO gives two options for working out each payment. Under the first, the ATO calculates the instalment amount and you pay that figure. You do not need to do any calculations yourself. This option suits owners who want a predictable payment.
Under the second option, the ATO gives you an instalment rate. You multiply your instalment income for the period by that rate. Instalment income is your gross business and investment income, excluding GST. The ATO gives the example of $106,000 multiplied by 11%, which comes to $11,660.
The rate option means payments move with your income. In a quiet quarter you pay less, and in a busy quarter you pay more. That can suit businesses with seasonal sales. Accurate sales records make this option much easier to manage.
Reporting and due dates
Businesses registered for GST report PAYG instalments on their business activity statement. Businesses not registered for GST use an instalment activity statement instead. The ATO usually sends the statement or an instalment notice at the end of each instalment period. Due dates are generally 28 days after the end of each quarter.
You still need to lodge an income tax return each year. The instalments are credited against the tax worked out on that return. If you paid too much through the year, the difference is refunded after you lodge. If you paid too little, the shortfall is payable.
Varying your instalments
Income can rise or fall sharply from one year to the next. The ATO lets you vary your PAYG instalments if they are too high or too low. You make the change on your activity statement or instalment notice. You must lodge it on or before the day the instalment is due.
A varied amount or rate applies to the rest of the instalments for that income year. It stays in place until you vary it again. Varying does not change the total income tax you owe for the year. It only changes how much you prepay along the way.
Varying too low carries a risk. If your varied instalments come to less than 85% of your total tax payable, you may be charged a general interest charge on the difference. Penalties may also apply depending on the circumstances. The ATO suggests that if you are unsure, it is best not to vary.
Leaving the system
If your income falls below the entry levels, the ATO removes you automatically. If you stop earning business or investment income, you may be able to exit. You can also ask to leave through ATO online services. A registered tax agent can help you decide if that is the right move.
Planning for tax as the business grows
As a business grows, its tax usually grows with it. A run of new customers or one large job can lift income faster than expected. Reviewing instalments after a strong quarter helps avoid a surprise at tax time. A yearly check with a tax agent keeps payments in line with how the business is really going.
Frequently asked questions
Do PAYG instalments mean I pay more tax?
No. They are prepayments of the tax you expect to owe, not an extra tax. At tax time they are offset against your final tax bill.
When are PAYG instalments due?
Most people pay quarterly. Due dates are generally 28 days after the end of each quarter. Check your activity statement or instalment notice for the exact date.
Can I join PAYG instalments if the ATO has not entered me?
Yes, you can ask to enter the system. Sole traders can do this through myGov, or through a registered tax or BAS agent. This can suit new businesses that expect a profit.
What happens if I vary my instalments too low?
If your varied instalments come to less than 85% of your total tax payable, a general interest charge may apply to the difference. Penalties may also apply. If you are unsure, the ATO suggests not varying.
This article is general tax information only and is not financial or tax advice. Tax rules change, so check the latest ATO guidance before acting. For advice on your own situation, speak with a registered tax agent or qualified accountant.