PAYG instalments explained for sole traders

A letter arrives saying you now have to pay tax quarterly, and nothing about the business has changed. That is pay as you go instalments, and it is not a new tax. The ATO’s PAYG instalments pages describe instalments as regular prepayments of the expected tax on your business and investment income, made during the year rather than in one amount after you lodge. Everything you pay is credited back against the tax on your return.

The mechanism is the same one an employee has had all along, where tax comes out of every pay. A sole trader gets paid gross, so the ATO asks for it in quarterly pieces instead. This page carries no year-specific dates and stays accurate whenever the letter turns up.

General information, not tax advice. The ATO is the authority - see ato.gov.au or ask a registered tax or BAS agent.

What the instalments are, and what they are not

They are income tax, paid early. They are not GST, and they are not an extra charge on top of your assessment. On a business activity statement they appear separately from the GST labels, which is the reason a BAS can be much larger than the GST you collected that quarter and still be correct.

They are also not a final figure. An instalment is the ATO’s estimate of what your tax will be, based on what you last told it. The return you lodge is what settles the actual amount, and the difference goes either way.

The one thing worth internalising early is that instalments do not increase what you owe for the year. They change when you pay it. A business that treats the quarterly amount as an unexpected cost rather than a prepayment of a bill already coming ends up surprised twice.

Why you were entered into the system

Entry is usually automatic and is based on your last return. The ATO’s starting PAYG instalments page says an individual, including a sole trader, or a trust automatically enters the PAYG instalments system where all of the following apply: instalment income from the latest tax return of $4,000 or more, tax payable on the latest notice of assessment of $1,000 or more, and estimated, or notional, tax of $500 or more.

Instalment income is defined on the same pages as your gross business and investment income, excluding GST and any capital gains. Gross, not profit, which is why a business with modest margins can cross the income figure without feeling prosperous.

Entry can also be voluntary. Where income has grown and the next assessment is clearly going to be larger than the last one, paying instalments through the year is a way of spreading a bill that is coming regardless. The other side of it is in the sole trader tax return and the 31 October deadline.

Instalment amount or instalment rate

There are two ways the quarterly figure is worked out, and which one you have is printed on the activity statement or instalment notice itself.

The instalment amount, option 1. A dollar figure the ATO has calculated from your last return, shown at label T7. You pay that amount each quarter regardless of what the quarter actually did. It is the simpler option and suits a business with steady income.

The instalment rate, option 2. A percentage, shown at label T2, which you apply to the instalment income you actually earned in the quarter. A quiet quarter produces a smaller instalment automatically, without you having to vary anything. It suits lumpy or seasonal work, at the cost of having to know your gross income for the quarter before you can lodge.

The ATO’s guidance on how to vary your PAYG instalments tells you to check which labels appear on your own statement, because the two options are varied differently and only one of them will be there.

When they are due

For most sole traders, the instalment is due quarterly. Where you are registered for GST and lodge a business activity statement, the instalment appears on that statement and is paid with it, on the BAS due date. Where you are not registered for GST, the ATO issues a quarterly instalment notice instead, with its own due date.

Either way the practical rhythm is the same, and it is the same rhythm as the rest of the quarter’s paperwork, which is covered in BAS due dates and how to prepare. An instalment notice with a pre-filled amount can be paid without lodging anything further, which is the one piece of ATO paperwork that genuinely takes a minute.

Varying an instalment, and the risk of going too low

If the year has turned out very differently from the one the instalment was calculated on, the amount or the rate can be varied. The ATO’s page on varying says the point is to bring the amount you prepay closer to your expected tax for the year, and it sets out the steps for each option separately.

The risk sits on one side only. The ATO says that when it receives your return it compares your actual instalments to the total tax payable on your instalment income for the year, and if your varied instalments come to less than 85% of that total, you may have to pay a general interest charge on the difference in addition to the shortfall, with penalties possible depending on the circumstances. Its own advice where you are unsure is not to vary, because any overpaid instalments are refunded after you lodge.

So the honest framing is that varying downwards is a judgement about your own year, made on your own numbers, with an interest charge attached if the judgement is wrong by enough. A variation that tracks a genuine, documented drop in income is a reasonable thing to do; one that guesses optimistic is a loan from the ATO at the general interest charge rate. A registered tax or BAS agent can run the comparison before you commit to it.

How instalments come off the final bill

Nothing is lost. The ATO’s page on the business income tax return says that where you have paid PAYG instalments during the income year, those instalments are automatically credited to you in your assessment. You do not calculate the tax yourself; the ATO does it on lodgment and issues an assessment showing either what is owing or your refund.

That produces one of three outcomes. The instalments roughly matched the tax, and the assessment is close to nil. They fell short, and there is a balance to pay, which is the normal result in a growing year. Or they overshot, and the excess comes back as a refund. Only the second one requires any planning, and the way to plan for it is to know roughly where the year has landed before October rather than on the day.

How Apsis helps

The figure every instalment is ultimately based on is your income, and Apsis records it as it happens: each invoice numbered, dated and issued from the same place, with the list filtering by status so paid, part-paid and overdue are visible without a reconciliation, and expenses logged with receipts against the same clients and jobs. That gives you a gross income figure for the quarter to sanity-check an instalment rate against, instead of a bank statement. Invoices and expenses with receipt upload are on the free plan, which covers 5 clients and 20 invoices a month. On the paid plan, the tax module’s income tax estimate gives you a running view of the tax the instalments are prepaying.