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What Are Payroll Withholding Taxes?

Automatically deducting income tax from payroll helps streamline tax collection. This is why governments around the world make withholding tax a requirement, and Australia is no different. So, what is withholding tax, and how do you set it up? Here’s what every business owner needs to know.

What is withholding tax?

Withholding tax is deducted from salaries, wages, and dividends – in short, any income received. The amount deducted is paid to the government, and then credited against the individual’s income tax liability.

What makes withholding tax different from any other type of income tax you might pay is that the tax is deducted at the point of fund disbursement. For payroll, this means a certain percentage of income is withheld from each cheque to cover the employee’s tax liability. The deduction is forwarded to the government entity, in this case the Australian Tax Office (ATO).

PAYG withholding tax requirements

If your business has employees, you’re required to register with the ATO for pay as you go (PAYG) withholding. You might also need to register if you make payments to contractors or other businesses.

The purpose of PAYG withholding is to prevent your workers from owing a large amount of income tax at the end of the financial year.

Here are the requirements to follow:

  1. Register for PAYG withholding with the ATO

  2. Pay the withheld amounts to the ATO

  3. Report the withheld amounts on your business statements

  4. Provide employees or other payees with PAYG summaries

  5. Submit a PAYG withholding annual report

Withholding taxes are applicable to any employees on your normal payroll, including salaried employees and workers paid an hourly wage. However, you might also have to register for PAYG if you make payments to:

  • Contractors that don’t provide an Australian Business Number

  • Workers with a voluntary agreement

  • Directors

If you operate as a sole trader and take money from your business accounts for personal expenses, this doesn’t qualify as a wage and thus no withholding tax is needed. However, you will need to still report this income on your end-of-year return.

Withholding tax rates

Your payroll withholding tax rates will depend on the state or territory as well as the level of income. To help calculate the correct rates, you can use one of the ATO’s tax withholding calculators.

  • Individual withholding calculator: This applies to employee payments

  • Voluntary agreement calculator: This applies to any payments made under a voluntary agreement

Another option is to use one of the government’s tax tables to determine what should be withheld from payroll.

How to calculate withholding tax

We’ve just outlined which calculators to use when working out how to calculate withholding tax. There’s some information that you’ll need to have ready in order to use these calculators and calculate the right tax rates. Before you get started, it’s important to pull together the following documents:

  • Tax file number declaration

  • Medicare levy variation declaration

  • Withholding declaration

You’ll need these for reference as you plug information into the calculator. Details like the following will ultimately determine withholding tax rates:

  • Medicare levy

  • Worker status

  • Income tax rates

  • Student loan contributions

  • Tax-free threshold amount

  • Additional tax entitlements

Once you’ve calculated the amount of withholding tax owed, you must take this from the employee’s pay and forward it to the ATO. Payment deadlines will depend on the size of your business.

  • Small withholders: If you withhold less than $25,000 per year, you must make quarterly payments.

  • Medium withholders: If you withhold between $25,000 and $1 million per year, you must make monthly payments.

  • Large withholders: Those that withhold over $1 million per year must make their payments within six to eight days.

Reporting withheld tax

Another factor to consider with payroll withholding taxes are the ATO’s reporting requirements. You must report all PAYG withholding on your Business Activity Statement (BAS) at the end of the financial year. You’ll also need to submit a summary to each payee for their own records.

All records need to be kept on file for at least five years. It’s a good idea to use accounting software to keep track of all aspects of payroll for tax purposes, so that you can easily refer back to your reports as needed.

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