PAYG instalments are regular prepayments towards the income tax you will owe on your business and investment income. The ATO enters you into the system automatically after a tax return shows enough business income — you do not opt in. The instalments are usually quarterly, they are reported on your BAS or on a separate instalment notice, and every dollar is credited against your final tax bill when you lodge. They are not an extra tax. They are the same tax, earlier.
PAYG instalments vs PAYG withholding
Two different things with confusingly similar names, and mixing them up is the most common source of panic:
| PAYG instalments | PAYG withholding | |
|---|---|---|
| Whose tax | Yours, on your own business and investment income | Someone else’s — an employee’s, or a supplier with no ABN |
| Who pays it | You, towards your own bill | You, on behalf of the person you paid |
| When it starts | When the ATO enters you, after a return crosses the thresholds | When you first pay wages, or pay a supplier who did not quote an ABN |
| Where it is reported | BAS labels T1, T2, T7 and 5A, or a separate instalment notice | BAS labels W1 and W2, and through Single Touch Payroll |
| What it becomes | A credit against your income tax assessment | A credit against the other person’s assessment |
Why you were put in the system
For an individual, the ATO enters you into PAYG instalments when your latest tax return and notice of assessment cross all of these:
- Instalment income of $4,000 or more in your latest return — broadly, your gross business and investment income, before expenses.
- Tax payable of $1,000 or more on your notice of assessment.
- Estimated tax for the current year of $500 or more.
Note the first test is on gross income, not profit. A sole trader turning over $60,000 with $56,000 of costs still has instalment income of $60,000. Different thresholds apply to companies and super funds, and there are exclusions — check ato.gov.au for your circumstances.
The ATO writes to tell you. It is easy to mistake that letter for information rather than an obligation, and the first instalment is due whether or not it was read.
The two ways to work out the amount
You choose one at the start of the income year, and the choice is generally locked in for that year.
| Option | How it works | Suits |
|---|---|---|
| Option 1 — instalment amount | The ATO works out a dollar figure from your last return and you pay that each quarter. Label T7. | Steady income year to year. Simplest: no calculation, no bookkeeping needed to work out the payment. |
| Option 2 — instalment rate | The ATO gives you a percentage. You multiply it by your actual instalment income for the quarter. Labels T1 and T2. | Variable or seasonal income. Instalments rise and fall with what you actually earned, so a quiet quarter costs less. |
Both are based on last year's figures, which is the source of nearly every problem with the system. A quiet year following a good one means instalments sized for income you are not earning.
Varying an instalment
If your income has genuinely changed you can vary the instalment amount or rate, on the activity statement, before its due date. This is a normal thing to do and the ATO expects it.
The catch is the 85% rule. If you vary down and your varied instalments for the year come to less than 85% of the tax actually payable on that income, the ATO can charge the general interest charge on the shortfall, and a penalty. Vary because the income changed, not because the instalment is inconvenient — and if you are guessing, guess towards paying more, because an overpayment comes back to you.
A variation applies from the quarter you make it onwards. It does not retrospectively fix earlier quarters.
The year-two squeeze
This is the part that catches almost every new sole trader, and it is worth planning for from your first invoice:
- Year one. You trade all year and pay nothing towards tax as you go, because nobody has assessed you yet.
- You lodge. A tax bill arrives for the whole of year one.
- The ATO enters you into instalments at the same time, based on that return.
- You now owe both — the year-one bill, and instalments towards year two, often within months of each other.
There is no trick that avoids it; it is simply the system catching up. The answer is to have been setting money aside from the start. A fixed percentage of every payment into a separate account, from day one, is the whole strategy — see how a sole trader is taxed.
Where it appears, and when
- If you are registered for GST, the instalment is a section on your quarterly BAS — labels T1, T2 and T7, with the amount payable at 5A. It is due on the same date as the BAS.
- If you are not registered for GST, the ATO sends a separate quarterly instalment notice instead.
- Some taxpayers pay annually rather than quarterly, where they meet the ATO's eligibility conditions.
- You can exit if your circumstances change and you no longer meet the entry thresholds — but do it through the ATO rather than by simply not paying.
Everything about the form itself is in what is a BAS?
Related reading
- How much tax does a sole trader pay? — what the instalments are prepaying
- What is a BAS? — the form the instalment sits on
- Sole trader tax deductions — reducing the bill the instalments prepay
- Can a sole trader have employees? — where PAYG withholding starts instead
Frequently asked questions
No. They are prepayments of the income tax you will owe anyway. Every instalment is credited against your assessment when you lodge, and if the instalments exceeded the tax payable the difference is refunded. The only thing that changes is the timing — you pay through the year instead of in one lump.
Entry is automatic once your latest return and assessment cross the thresholds — for an individual, instalment income of $4,000 or more, tax payable of $1,000 or more, and estimated tax of $500 or more. The ATO writes to tell you rather than asking, and the first instalment is due whether or not the letter was actioned.
Yes — you can vary the amount or rate on the activity statement before its due date, and you should if your income has genuinely fallen. But if your varied instalments come to less than 85% of the tax actually payable, the ATO can apply the general interest charge and a penalty on the shortfall. Vary because the income changed, and if in doubt vary towards paying more.
Interest accrues on the unpaid amount, and the liability does not go away — it is added to what you owe at assessment. If you cannot pay, contact the ATO about a payment plan before the due date rather than after. The system is much easier to deal with in advance than in arrears.
Yes, always. Instalments are estimates based on last year; the return is what actually determines the tax. The instalments you paid appear as credits, and you either pay the shortfall or receive the excess back. Nothing about being in the instalment system reduces the lodgement obligation.
Sources
Entry thresholds, the two calculation options, the variation rules and the 85% rule come from the Australian Taxation Office. Thresholds and rates change — confirm the current position at ato.gov.au or with a registered tax agent. Balaana is bookkeeping software, not a tax agent — this article is general information, not personal tax advice.