For most people the amount of tax your employer takes out of your salary each pay is calculated on your expected yearly salary. At tax time, your tax refund is calculated by working out how much tax you’ve paid during the year minus how much tax you should have paid based on your taxable income.
This is the important part – your taxable income is your yearly total income (salary, interest, dividends etc.) minus your deductions and losses.
Some people may find that their taxable income is often much smaller than their yearly salary. This, in turn, means a much bigger tax refund. The most common time I see this is with people who have an investment property which is negatively geared. This means the property makes a loss each year and, if the loss is significant, it can have a big impact on reducing their taxable income.
People with a large amount of out-of-pocket work-related expenses each year may also find themselves in this position. This is common for tradespeople, real estate agents, lawyers and doctors, who often have several thousand dollars of deductions each year which lowers their taxable income.
One option for you if you are in this situation is to have your employer reduce the amount of tax you pay on your salary and increase your take home pay. Keep in mind, though, this will reduce your tax refund at tax time.
On the flipside, if you receive large amounts of income on which you don’t pay tax on during the year (for example, large interest payments or an investment property which generates positive income) you may find that your taxable income is higher than your yearly salary. In those cases, the amount of tax you’ve paid might not be enough and you’ll have a bill at tax time. To avoid this, you can ask your employer to take more tax out of your pay and avoid the bill.
In both scenarios, this is done by a process called ‘Varying Your PAYG Withholding’.
Vary your PAYG to increase your take home pay
In simple terms, your tax refund can be thought of as an interest-free loan to the government which they repay to you each year when you do your tax return. If you regularly have a large tax refund, then it’s like you’re giving the government a large interest-free loan each year.
You might therefore consider whether you should reduce the amount of tax you pay each pay day. This will mean more money in your pocket each pay day and a smaller refund at tax time.
Unfortunately, in these cases it’s not as simple as just speaking with your employer. The Australian Taxation Office (ATO) also has to sign off on this arrangement via the submission of a PAYG withholding variation application, which you can do yourself or ask your tax agent to submit on your behalf.
Mary earns $110,000 each year from her employer. She has two investment properties which are negatively geared. She estimates her total rental property loss for the year will be $20,000.
Therefore, her total estimated taxable income will be $110,000 minus $20,000 = $90,000.
Instead of receiving a large tax refund, Mary wants to boost her take home pay, so she speaks with her tax agent who submits a PAYG withholding variation application on her behalf to the ATO.
Once processed by the ATO, she provides the approved application form to her employer who then adjusts her tax rate to be calculated based on a taxable income of $90,000 (instead of her yearly salary of $110,000).
Vary your PAYG to avoid a bill at tax time
If you have a tax bill each year, you can ask your employer to increase the amount of tax that is withheld from your pay.
This process is simple, and you can put the request to your employer in writing to increase your tax rate based on your expected taxable income.
John earns $75,000 each year from his employer. Due to an inheritance he also has a large sum of money in a term deposit. John estimates he will receive $7,000 of interest from this term deposit.
Therefore, John’s taxable income will be $75,000 + $7,000 = $82,000.
If his employer taxes him as though his income is $75,000, he won’t have paid any tax on the additional $7,000 and may find he has a tax bill when he submits his tax return.
To avoid this, John asks his employer to have his tax rate calculated on a yearly taxable income of $82,000 instead.
What happens if your taxable income estimate is incorrect?
As mentioned earlier, your tax refund is calculated based on the amount of tax you paid during the year versus how much you should have paid based on your actual taxable income.
This means if you vary your tax withheld up or down and your circumstances change things will be balanced out at tax time:
- If you pay too much tax each pay you’ll end up with a bigger refund.
- If you pay too little tax each pay (because your taxable income wasn’t as low as you estimated) you may find yourself with a bill come tax time.
In this situation the ATO won’t penalise you, however you will have to pay any amount owing by a due date set by the ATO otherwise you could face interest charges.
Need to know
Varying your PAYG withholding can be tricky to navigate. My suggestion would be to never enter into an arrangement to vary your PAYG withholding amount without first speaking to your tax agent or accountant.
They will be able to run the numbers for you and confirm whether this arrangement makes financial sense for you based on your personal circumstances.
Cover image source: RomanR (Shutterstock)
About Liz Russell
Liz Russell is a senior tax manager at Etax.com.au. She has been with the company since it launched in 1998 and brings more than 40 years of tax experience to the table. Her expertise lies within complex individual tax returns.