You lodge a good tax return, pay the bill, and think you are done. Then a letter turns up from the ATO telling you that you are now on PAYG instalments. If your first reaction is "is this a second tax bill?", you are not alone. It is one of the most common panic calls we get from sole traders and growing businesses.
The short version: it is not an extra tax. It is the ATO asking you to pay this year's tax in smaller chunks along the way, instead of one big hit after you lodge. Here is how it actually works.
What PAYG instalments really are
PAYG stands for pay as you go. Employees have tax taken out of every pay by their employer. If you run a business or earn investment income, no one is doing that for you, so the ATO asks you to do it yourself in regular instalments.
Each instalment is a prepayment towards your expected tax bill for the current year. When you lodge your return at the end of the year, the ATO adds up everything you have already paid in instalments and credits it against your final bill. If you have paid too much, you get it back. If you have paid too little, you top up the difference. You are not paying tax twice, you are paying it earlier.
Why you suddenly got put on them
The ATO does not put everyone on instalments. For individuals and sole traders, it happens automatically when your last return shows all three of these: business or investment income of $4,000 or more, tax payable on your notice of assessment of $1,000 or more, and estimated (notional) tax of $500 or more.
In plain terms, once your business starts making real money and you have a tax bill that is no longer tiny, the ATO stops waiting until the end of the year to collect. Companies get entered on a different test, generally once instalment income hits $2 million or notional tax is $500 or more.
So getting the letter is usually a sign your business is growing. Annoying timing, maybe, but not a punishment.
How much and how often you pay
Most people pay quarterly. The standard due dates are 28 October for the July to September quarter, 28 February for October to December, 28 April for January to March, and 28 July for April to June.
The ATO gives you two ways to work out each payment. The first is the instalment amount, where the ATO simply tells you a dollar figure based on your last return and you pay it. The second is the instalment rate, where you apply a percentage the ATO gives you to your actual income for the quarter, so the payment moves up and down with how the business is going. The dollar amount is the least effort. The rate method suits businesses whose income swings a lot through the year.
Some smaller taxpayers can pay a single annual instalment instead of four, and certain primary producers and seasonal earners have their own arrangements. If you are not sure which applies to you, it is worth a quick check rather than a guess.
Getting a surprise instalment notice is exactly the kind of thing worth a fast answer. If you want a straight explanation of your situation, book a free call and we will walk you through it.
The trap most people fall into
The figure the ATO gives you is based on last year. If this year is bigger, the instalments can leave you short at tax time. If this year is smaller, you can end up handing the ATO more than you owe and waiting to get it back, money that could have stayed in your business.
You are allowed to vary an instalment if you genuinely expect your income to be different. That can be a smart move when your circumstances have clearly changed. Be careful though: if you vary your instalments down too far and it turns out you underpaid, the ATO can charge interest on the shortfall. Vary based on real numbers, not hope.
How to stop instalments from hurting your cash flow
The businesses that handle instalments well treat them as part of normal running costs, not a surprise. A few habits make all the difference.
Set money aside as you earn it, so the quarterly payment is already sitting there when the due date arrives. Put the four dates in your calendar now. Keep your bookkeeping current so you always know roughly what you owe. And review your instalments partway through the year, because a business that has grown or slowed is rarely well described by last year's numbers.
Done properly, instalments are actually easier on your cash flow than one giant bill in the middle of the year. The problem is almost never the instalments themselves. It is being caught off guard by them.
The bottom line
PAYG instalments are not a new tax and they are not a mistake. They are the ATO collecting your tax in steady steps because your business has grown enough to matter. Understand why you are on them, pick the method that suits how your income behaves, and keep an eye on whether the amounts still fit your year. Do that and they become a non event.
If a PAYG instalment notice has landed and you are not sure what to do with it, we are happy to help. Book a free call and get a clear answer, with fixed fees agreed upfront and every question answered within 24 hours.
This article is general information only and does not take your personal circumstances into account. For advice specific to your situation, please get in touch.
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