So we asked Electra Frost of Electra Frost Accounting to lift the lid on PAYG. In this 2 part blog series she shares some great tips and advice on how to approach PAYG as a freelancer or sole trader.
In part 1, Electra explores the basics of PAYG.
As a freelancer managing business finances can be stressful. Few things are more stressful than an unexpected bill from the Australian Tax Office (ATO). Especially if the effort has been made to stay on top of business finances and lodge a tax return on time.
Unexpected tax bills can be a common occurrence for freelancers in the first 12-18 months of business so understanding why it happens and what to do next is crucial.
The sheer quantity of information on the ATO website can make it challenging to find answers. Even finding out the right questions to ask is hard so here we will uncover exactly what PAYG instalments are, how they impact your approach to managing cash flow and how you can work with the ATO to leverage PAYG instalments into an advantage for your business.
What are PAYG Instalments?
PAYG stands for “Pay as you go”. It’s the ATO’s way of spreading a tax bill over the year rather than waiting until the end of the financial year to collect it all at once. The ATO work out how much will be owed for the next financial year based on the income declared in the most recently lodged tax return.
Initially the ATO will calculate the amount of the quarterly instalment however it is possible to calculate your own instalments based on actual current year income - more on that later.
The ATO sends PAYG instalments quarterly* and the amount paid is offset against the end of financial year (EOFY) tax return. Any excess paid is repaid as an EOFY tax refund. Similarly any shortfall results in a tax bill however bear in mind it will be considerably smaller had PAYG instalments not been paid over the course of the financial year.
*PAYG instalments can sometimes be monthly but in this blog we assume quarterly payments.
Who qualifies for PAYG instalments?
It’s compulsory for all Australian taxpayers who report $4,000 or more gross business and/or investment income in their tax return, and owe more than $1,000 tax. Business income is generally what is earned via an ABN and investment income includes bank interest, rent, etc.
PAYG instalment income does not include wages and salary income from which PAYG is normally withheld by an employer.
At what point will the ATO put me on to PAYG instalments?
Generally it will happen after an EOFY tax return has been submitted which meets the criteria described in the last section. If a tax return lodgement meets the right criteria, the ‘ATO super computer’ should automatically send a “Welcome to the PAYG System” letter. It may say “you do not need to do anything right now… we will send you statements later”.
This is a cue to begin preparations for the quarterly PAYG instalment ‘activity statements’ that will be received.
To report and pay instalments, the ATO send taxpayers either:
1. PAYG Instalment Notices – Quarterly payment notices calculated by the ATO. These detail what to pay or give you the option to vary the amount before the date the ATO amount falls due.
2. Instalment Activity Statements (IAS) – The option to self calculate the instalment amount based on actual income and a percentage rate.
3. Business Activity Statement (BAS) – For those who are GST registered, a BAS will include the options above of paying PAYG instalments.
A couple of quick steps can make the process easier from the outset:
1. Register for MyGov and link your ATO account. Here you will be able to update contact details, access and lodge Activity Statements and see due dates and amounts owing.
2. Check the ATO have the correct mailing address on file for ‘activity statements. It will have to be provided separately as the ATO system won’t use the address listed for income tax updates by default. Completing step 1 makes this quick and easy.
3. Make sure year-to-date business income and expenses are entered in to an accounting system like Rounded which is made for freelancers and sole traders.
Having taken the above steps any PAYG notices will arrive at the right place with enough time to get answers to any questions from a tax accountant or the ATO prior to payments being due.
If managed correctly PAYG instalments should be a good thing for freelance businesses. They help to spread income tax liability over the course of the financial year and limit the stress caused by the prospect of a massive tax bill at the end of the financial year.
In Part 2 of this series we’ll look more closely into the different options for managing PAYG instalments including varying payment amounts and preparing an annual tax estimate.
*Electra Frost is the Principal of Electra Frost Accounting, a Chartered Tax Adviser and Accountant who has worked with freelancers and the creative industries for 20 years.
Please be aware that all of this information is general in nature; it does not take into account your own circumstances and, as such, is not intended to be taken as advice. Should you require further information or assistance with your PAYG instalments seek professional advice.
If you would like to talk to the team at Electra Frost about PAYG you can book a video meeting here or contact them via 1300 546 770 or firstname.lastname@example.org