How the Pay (PAYG) Tax Instalment System Works

If you’ve ever worked in Australia, you’ve probably heard the term “Pay As You Go” (PAYG) tax system. But what exactly does it mean? How does it work? And why is it important for you as a taxpayer? Well, let’s break it down in a way that’s easy to understand.

What is PAYG?

The Pay As You Go (PAYG) system is a way of collecting income tax in Australia. Instead of waiting until the end of the year to pay your entire tax bill, the PAYG system breaks it up into smaller, more manageable instalments that are paid throughout the year.

The Australian Taxation Office (ATO) uses this system to help you pay your income tax gradually, so you’re not hit with a massive tax bill at the end of the year. It’s like paying for your car or phone in monthly instalments rather than all at once—less stress, right?

How Does PAYG Work?

Here’s the basic rundown: PAYG works by having your employer (if you're working for someone) or you (if you're self-employed or running a business) deduct tax from your income and send it directly to the ATO.

Let’s break it into two parts:

1. PAYG Withholding: This is the part of the PAYG system that applies to employees. Each time you receive your paycheck, your employer will withhold a portion of your income as tax and send it directly to the ATO on your behalf. This means you don’t have to worry about tax deductions at the end of the financial year because your employer is already doing that for you.

For example, if you earn $2,000 a fortnight, your employer may withhold $200 in tax. This will be paid to the ATO, and at the end of the financial year, your tax return will show the tax already paid.

2. PAYG Instalments: If you're self-employed as a business owner, or have investment income, you pay your own tax through PAYG installments. Instead of having an employer withhold tax for you, you will make regular installment payments throughout the year based on your expected income. These installments are calculated by the ATO and levied on you every quarter in advance, but you can adjust them if your income changes.

For instance, if you have investment income and your tax estimate is $5,000 for the year, you might have to pay quarterly instalments of $1,250 (assuming your income remains consistent). If your income goes up or down, you can adjust the amount you pay.

Example 1: PAYG Withholding for Employees

Imagine Sarah works full-time in retail. She earns $50,000 a year. Her employer calculates that her tax liability for the year is around $7,500, and based on this amount, they withhold a portion of her income each pay cycle. So, every fortnight, a certain amount of her $1,923 paycheck goes towards her income tax.

At the end of the year, Sarah files her tax return. If the amount her employer withheld is the same as what she owes, she doesn’t need to pay any more. If more was withheld than required, she’ll get a refund. If less was withheld, she’ll owe the difference.

Example 2: PAYG Instalments for the Self-Employed

Let’s take Tom, a freelance graphic designer. Tom doesn’t have an employer to deduct tax for him, so he needs to pay PAYG instalments directly to the ATO. After reviewing his tax history, the ATO estimates that Tom will owe $6,000 in tax for the year based on his income from the previous year.

The ATO sets up quarterly instalments of $1,500. Tom can choose to either stick with the ATO’s estimate or adjust it if he expects to earn more or less in the current year. At the end of the year, when he lodges his tax return, he will either receive a refund or pay any additional tax that’s due based on his actual income.

How Are PAYG Instalments Calculated?

For employees, the amount withheld is based on the income you earn and the tax rates applicable to that income. The ATO uses tax tables to determine how much to deduct, depending on how much you earn each period.

For self-employed individuals or businesses, the ATO usually estimates your PAYG instalments based on your most recent tax return. However, you can adjust the instalments up or down if you expect your income to change. The ATO will send you a notice to remind you when payments are due, and you can pay online through the ATO’s portal.

What Happens If You Don't Pay Your PAYG Instalments?

It’s important to keep up with your PAYG instalments to avoid penalties. If you miss a payment or underpay, the ATO may charge you interest or penalties for late payment. The key is to stay on top of it and pay on time.

That said, if your circumstances change (like if you earn less than expected), you can contact the ATO to adjust your instalments. It’s all about keeping things manageable.

Can You Claim Back Overpaid Tax?

Absolutely! If you’ve paid too much tax throughout the year (whether through PAYG withholding or instalments), you might be eligible for a refund when you submit your tax return. The ATO will review your earnings, tax payments, and deductions to determine if you’ve overpaid, and if you have, you’ll get that extra money back.

Key Takeaways

• PAYG is a way to pay your income tax gradually throughout the year.
• For employees, it’s usually withheld automatically by your employer.
• If you’re self-employed or running a business, you’ll make quarterly PAYG instalments to the ATO.
• PAYG helps you avoid a massive tax bill at the end of the year, keeping your payments manageable.
• It’s important to keep up with your PAYG payments to avoid interest and penalties, but you can adjust your instalments if your income changes.

So, whether you’re an employee with tax withheld from your paycheck or a business owner making PAYG instalments, understanding how the system works can help you stay on top of your tax responsibilities and avoid any surprises down the line.

Got any questions about PAYG or want to dive deeper into tax tips? Please make an appointment to speak with us.

Chris Tolevsky has over 30 years experience in the medical and allied health fields.  He provides expert guidance on tax strategies, building and protecting wealth . If you’re interested in discussing how we can help you please book a complimentary consultation. 

Disclaimer: This article contains general information only . It is not designed to be a substitute for professional advice and does not take into account your individual circumstances, so please check with us before implementing this strategy to make sure it is suitable