Being self-employed, or a sole trader, you’ve likely heard about PAYG instalments before. But when they finally hit you, they can come as a nasty shock. Depending on your growth and profit increase, you can be hit with almost double taxation in a particular year (as you will have just paid a tax bill when your PAYG instalments first become due). That can make it difficult to manage.
So, what is PAYG? How do they impact you as a self-employed taxpayer? And what can you do to manage them and mitigate your tax payable at the same time?
PAYG is simply an acronym that stands for ‘pay as you go’. It refers to the Australian Tax Office’s (ATO) process for spreading out an individual or entity’s tax payments over the course of a financial year.
As an individual taxpayer with a traditional employer, you would have been used to the withholding system (also known as PAYE or ‘pay as you earn’). This is where your employer would pay you but withhold a certain percentage for tax purposes. At the end of the year you would file your taxes and your net tax would be calculated. In most cases you would either owe a small amount or receive a small refund.
With PAYG, your tax is instead estimated and calculated quarterly, or in some cases even monthly, and payments required at the same time. And this is the method that typically applies for freelancers, sole traders and the self-employed.
In your first year or two as a self-employed taxpayer, you may not have to worry about PAYG. However, once your new business starts to earn money, it won’t take you long to be on the hook. PAYG instalments are mandatory for any individual taxpayer who reports $4,000 more in business income. Since business income includes any money you receive from clients using your ABN, it doesn’t take too long to reach this point in your business journey.
It’s likely that as a sole trader or self-employed taxpayer, PAYG will apply to you. And once you reach the threshold, the ATO will send you a PAYG activity statement and an instalment request following the end of the current financial year (30 June). Once those requests come through, you’ll be expected to file and pay on the ATO’s schedule.
While you won’t really be on the hook for double taxation, it can feel like it in that first year. After all, you will have just paid (or perhaps not even paid yet!), your last end-of-year tax bill, when your first instalment request comes through. So, in effect, you’ll be paying all of the previous year’s tax, plus this year’s tax within the current financial year. And that can be a difficult task to manage.
Luckily, there are ways that you can better manage your PAYG tax so that you don’t end up paying more than you need to. We reached out to David Sneesby, chartered accountant and partner at Merrotts Chartered Accountants & Business Advisers, for some expert advice.
Setting up the right structure for your business can help mitigate your possible tax payments. Each business structure has different tax obligations and is taxed in different ways. While at this stage you may be operating as a sole trader, in time, this may need to change.
David says, ‘Sole traders pay tax as individuals and at the same tax rate. However, as your business income grows, you may be able to pay less tax as well as protect your personal assets by converting your business operations to a company structure. Most companies in Australia will be taxed at a rate of 25% for 2021-22 and future years if they qualify as a base rate entity. Most operating businesses should qualify. On the other hand, the highest tax rate for individuals in 2021-22 is 47% including Medicare levy. A restructure to a company could mean tax savings in the long run as long as it is completed correctly. You should talk to your accountant about this option to see if it could work for you’.
You might also consider setting up a dedicated tax account. Calculate your approximate PAYG instalments each week, fortnight or month based on your income. Then you would simply put that money aside in a separate account to cover your future instalment requests.
The ATO has a free PAYG instalment calculator which can help you estimate the amount of money that you should be putting away each period. And this is also something that your bookkeeper or accountant can help you to estimate.
David reminds us, ‘Regardless of how often your payment requests come up, you should work with your accountant to make tax estimates fairly frequently, especially as your income changes (a common occurrence for the self-employed). That way you can be sure that you’re setting aside enough income each period’.
Another way to manage your self-employed PAYG payment requirements is to set up a payment plan with your accountant. Your accountant will begin by estimating your income for the following year, and then you can arrange to save a portion of that estimated amount this year.
David says, ‘Setting up an internal payment plan ensures that you aren’t left in a lurch when next year’s requirements come up. Better yet, you don’t run the risk of overspending cash that’s available but should really be earmarked for the taxman’.
If you’re finding it tricky to make your instalment payments the ATO does allow you to request a variation. This could be especially useful in the early days of your self-employed PAYG.
‘Varying your PAYG instalments is a good move if you have fluctuating income. It will give you a chance to make your payments more manageable whilst minimising the potential of underestimating your tax payable which could lead to interest and penalties being imposed by the taxman’, David says.
If you do go down this road it’s a good idea to get an accountant involved. David says, ‘An accountant will help you better track your finances so you can avoid being hit with an unexpected tax bill, or instalments that you just aren’t prepared for’.
If you’re looking for a trustworthy broker who will get to know you and your unique situation, contact us.
This article is intended to provide commentary and general information only. It should not be relied upon as financial advice. It is always best to speak with your own financial adviser or accountant and formal financial advice should be sought if you have a particular matter of interest arising from this article.
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