How PAYG instalments work
PAYG quarterly instalment system – like a car!
The PAYG instalment system is like a car. It is simple – it has an engine and it takes you places.
While I don’t need to understand how the engine works, by doing certain things (like taking off slowly, not running the air conditioner at the bottom temperature and not carrying around heavy weights) – I can reduce my spending on petrol and look after my car better.
Concept 1: PAYG instalments – so Business Owners and Investors pay tax quarterly
The PAYG instalment system is designed so that those earning non-salary income (business owners, investors and employee shares) pay a quarterly amount towards their next year’s tax return.
The system is not limited to business owners or investors, but generally on income that could be deemed to be recurring.
For example: Those who receive Employee Options or Shares income may also be required to pay PAYG instalments.
When do I start to pay PAYG instalments?
You are entered into the PAYG instalment system after you have additional tax to pay of $2,000 or more on your tax return.
PAYG instalments are estimates – but are required to be paid
Although PAYG instalments are only estimates towards next years’ tax return, they are a debt and are required to be paid by the due date (unless you enter into a payment arrangement).
When do PAYG instalments change?
Instalments continue at the same amount or rate (most people choose to pay the amount) until a new tax return or a PAYG instalment variation is processed.
It is best to work through an example to explain how it works.
Year 1: Jo $10k tax on return
Jo has $10,000 tax on her tax return. Her PAYG instalments may be based on a different number than $10,000, but to keep it simple assume $10,000 is the starting number.
Concept 2: GDP Uplift
The GDP uplift is a percentage increase to countUsually there is an uplift factor up to 8%, so $10,000 becomes $10,800 estimated future tax. For 2020 returns lodged for 2021 instalments there is no uplift so Jo’s instalments are based on $10,000.
Quarterly year 1.
If Jo is new to PAYG, she will pay 25% e.g. $2,500 per quarter. This will continue until she varies or lodges next years tax return. So Jo has a March quarter instalment of $2,500 due 28 April and a June quarter instalment of $2,500 due 28 July.
Jo will have $5,000 of instalments to include in her 2021 tax return.
Say her ‘normal’ tax would have been $12,000, the $5,000 she has already paid means she will be required to pay another $6,000 after she receives her 2021 notice of assessment.
Year 2: Increase Jo increased PAYG instalments Year 2
We lodge Jo’s 2021 tax return in March 2022. As she is already on the PAYG instalment system, her March 2022 instalment is calculated at 75% through the year LESS instalments paid. E.g. $12,000 x uplift (assume 0% for ease of calculation) x 75% = $9,000 less $5,000 instalments paid ($2,500 for Sept & Dec) = $4,000 in March then 25% x 12,000 for June $3,000. $3,000 will be her new instalment until she lodges next year.
Is there anything else that is useful to know?
A Quarter is 25%, so in the 2nd year the tax year progresses the Tax required
Sept 25%, Dec 50%, Mar 75%, June 100%.
Year 3: Decrease/Stop Jo changes to company
Jo changes to a company structure through the year. She would continue to pay $3,000 per quarter until a tax return is lodged (or we vary the instalment). We lodge her return in January, so she has paid $6,000 ($3,000 x 2 instalments). The ATO reduce the next instalment to $1,000 per quarter based on her income, but we vary the instalment to nil and claim a refund back of $500 based on what we estimate her 2022 tax to be.
Or Jo decides to continue to pay $1,000 per quarter and lodge her tax return early to stop the PAYG system.