PAYG instalments (Pay as You Go)

PAYG Instalments: What You Need to Know

PAYG (Pay As You Go) instalments is a system administered by the Australian Taxation Office (ATO) that allows individuals and businesses to make regular payments toward their annual tax liability. Instead of paying a lump sum at the end of the financial year, taxpayers can spread their payments throughout the year, which helps avoid the stress of having a large tax bill come due all at once. PAYG instalments aim to ease cash flow management and ensure that taxpayers keep up with their tax obligations progressively.

The system primarily applies to those who earn income from business activities, investments, or other sources outside of regular salary and wages. These instalments are credited toward your final tax liability, and any overpayments result in a refund, while underpayments result in a balance owed to the ATO.

Eligibility for PAYG Instalments

To be placed in the PAYG instalment system, an individual or business must meet specific criteria. You will be required to enter the instalment system if:

• Your income from business and/or investments exceeds $4,000.
• Your most recent Notice of Assessment shows a tax payable amount exceeding $1,000.
• Your estimated (notional) tax on business or investment income is $500 or more.

When these thresholds are met, the ATO will automatically notify you that you need to start paying PAYG instalments. However, it’s also possible to voluntarily opt into the system if you anticipate a significant tax liability from business or investment income.

How to Pay PAYG Instalments

There are two primary methods for calculating and paying PAYG instalments, each providing some flexibility based on individual preferences or business cash flow:

1. ATO Calculated Instalment Amount:
   This option is the most commonly used by my clients, and it involves paying a set amount determined by the ATO. This figure is based on your last income tax return and is calculated using your tax liability for that year. It is a straightforward option as you don’t need to make any further calculations—simply pay the amount indicated on your instalment notice.
2. Income-Percentage Method:
   The second option allows you to calculate your instalment based on a percentage of your instalment income for the period. The ATO provides this percentage, and it is applied to the instalment income you earn in each period. This option can be more flexible if your income varies significantly from period to period. For example, if your income decreases in a particular quarter, your PAYG instalment would also be reduced.

PAYG Instalments and End-of-Year Tax Return

PAYG instalments are essentially prepayments toward your final tax liability. When your tax return is lodged at the end of the financial year, the instalments you’ve made throughout the year are subtracted from the amount of tax due.

• Overpayment: If you’ve paid more than what is owed, the excess amount will be refunded to you after your return is processed.
• Underpayment: If your instalments fall short of your total tax liability, you will be required to pay the difference. In some cases, this may include interest charges.

Exclusions and Exceptions

Not everyone is required to enter the PAYG instalment system. The following individuals are exempt:

• Individuals whose notional tax (the ATO’s estimate of the tax payable on your business or investment income) is less than $500.
• Those entitled to the seniors and pensioners tax offset.
• Individuals whose total instalment income falls below $4,000.

These exclusions help ensure that those with minimal business or investment income or those with certain tax offsets are not unnecessarily burdened by the instalment system.

Automatic Entry into PAYG Instalments

Once you meet the eligibility criteria, the ATO will automatically place you in the PAYG instalment system. After receiving your latest Notice of Assessment, you will be informed that PAYG instalments will begin for the following year. You do not need to do anything to initiate this process—it happens automatically based on the information provided in your tax return.

Voluntary Entry into PAYG Instalments

In some cases, you may know in advance that you’ll be required to pay PAYG instalments in the future based on your expected income. Rather than waiting for the ATO to notify you, you can voluntarily opt into the system. This can be useful if you wish to manage your cash flow proactively by paying smaller amounts toward your tax liability throughout the year.

To opt in voluntarily, you simply need to contact the ATO and provide an estimate of your expected tax liability for the year. For example, if you expect to owe $8,000 in tax, you can arrange to pay $2,000 per quarter, which equates to approximately $155 per week. This allows you to budget more effectively and avoid any surprises at tax time.

Varying Your PAYG Instalments

Circumstances can change, and so can your income. If your income fluctuates significantly, or if your current year’s income is notably different from the previous year, you can vary the amount of your PAYG instalments accordingly. For instance, if your income drops due to reduced business activity, you can decrease your instalment payments.

However, if you vary your instalments downward, the ATO will later check whether the total instalments you’ve paid for the year are at least 85% of your actual tax liability. If they are less than this amount, the ATO may apply a general interest charge (GIC) to the shortfall.

Instalment Frequency

Most taxpayers are placed on a quarterly PAYG instalment cycle. This means you will be required to make four payments throughout the year:

• 28 October
• 28 February
• 28 April
• 28 July

Each payment typically represents 25% of your estimated annual tax liability. For some individuals or businesses, particularly those with lower notional tax liabilities (less than $8,000 annually), there may be an option to pay annually instead of quarterly. Annual PAYG instalments are due on 31 October following the end of the financial year.

In some cases, primary producers or individuals in specialised professions such as sports professionals or authors may qualify for a biannual instalment option. Under this method, 75% of the annual PAYG liability must be paid by 28 April, with the remaining 25% due by 28 July.

Exiting the PAYG Instalment System

You will exit the PAYG instalment system if any of the following apply:

• Your instalment income falls below $4,000.
• Your tax liability falls below $1,000.
• Your notional tax is less than $500.
• You are entitled to the seniors and pensioners tax offset.
• You lodge a final tax return or your accountant lodges a “further return not necessary.”
• You notify the ATO that you do not need to lodge a return.

Additionally, if your circumstances change significantly, such as a major reduction in business or investment income, you can contact the ATO to request removal from the PAYG instalment system. However, simply preferring to pay your tax at the end of the year is not considered sufficient reason to exit the system.

What Counts as Instalment Income?

Instalment income includes a variety of sources, primarily from business and investment activities. Below is a list of income types that are considered instalment income. If the total from these sources exceeds $4,000, you will meet the criteria for PAYG instalments:

• Gross rent from investment properties.
• Dividends received or reinvested (excluding imputation credits).
• Royalties.
• Assessable foreign pensions.
• Your share of partnership or trust income.
• Foreign income.
• Interest received or credited.
• Gross sales (excluding GST).
• Fees for services provided (excluding GST).
• Income earned from selling goods or services.
• Gross amounts of income where tax was withheld because a Tax File Number (TFN) or Australian Business Number (ABN) was not provided.
• Withdrawals from farm management deposits.
• Fuel tax credits.

Conclusion

The PAYG instalment system is a practical tool designed to help Australian taxpayers manage their tax obligations throughout the year, avoiding the need for a large lump-sum payment at the end of the financial year. By understanding the system, its eligibility requirements, and payment options, you can make informed decisions about how best to manage your tax payments and avoid any unnecessary surprises. For more tailored advice, it’s always best to consult with a registered tax agent who can help navigate the complexities of your individual situation.