Navigating provisional tax can often feel daunting for new sole traders. Don’t worry; it’s simpler than it sounds, and we’re here to guide you through it, step-by-step. Whether you’re exploring provisional tax for the first time or seeking to refine your existing knowledge, this guide is tailored to simplify provisional tax and ensure you’re well-prepared.
What is provisional tax?
Provisional tax is not a seperate tax from income tax. Provisional tax is simply payments of your income tax during the financial year so that you don’t have to pay all of your income tax in one big payment at the end of the financial year – it should really be called ‘provisional payments’ instead of a tax.
Payments of provisional tax are usually 4-monthly (3 per year), or 6-monthly (2 per year) if you have 6-monthly GST.
Do I have to pay provisional tax?
If this is your first year being self-employed you don’t need to pay provisional tax (but you still have to pay income tax at the end of the financial year).
You have to pay provisional tax if your tax bill was more than $5,000 for the previous financial year.
To be sure if provisional tax applies to you, you can check your myIR account. In your myIR account, click the More… link for Income tax, then click View account registration details. If a ‘Prov tax method’ is displayed in the list then provisional tax applies to you.
How is it calculated?
There are a few methods to calculate your provisional tax, but the most common for sole traders are the ‘standard option’ and the ‘estimation option’.
- Standard Option: This is based on your previous year’s income tax plus 5%. It’s straightforward and often used by businesses with stable or increasing income.
- Estimation Option: If you believe your income will be lower than the previous year, you can estimate your tax for the year. This method requires a good understanding of your expected earnings and expenses.
If you paid more than $5,000 of tax in your first year being self-employed, you will automatically be placed on the standard option.
Provisional tax dates
4-monthly is the default provisional tax frequency, unless you file 6-monthly GST returns. If you file 6-monthly GST then you will also pay 6-monthly provisional tax.
|Period start date
|Period end date
What if my income drops during the year?
If your income decreases during the year you can use the ‘estimate option’ to update the IRD’s provisional tax estimate.
To update the IRDs estimate in your myIR:
- Log in to myIR.
- Click Estimate provisional tax under ‘Income tax’ in your summary.
- Click Next.
- Enter the year tax estimate in the New provisional tax estimate box and click Next.
- You will see an updated provisional tax amount for each instalment. Click Submit.
You can update your estimate multiple times throughout the year if your situation changes.
How to pay provisional tax
To make a provisional tax payment to the IRD, visit your online banking website and use the “pay tax” function to pay the IRD. Select ‘INC – Income Tax or Provisional Tax’ as the tax type and remember to enter your IRD number in the particulars.
If you’re GST registered, you can also pay provisional tax as part of filing your online GST return.
Tip: Consider setting up a separate savings account for tax payments. Regularly setting aside a portion of your income will make provisional tax payments much less scary.
Solo’s unique approach to provisional tax
The big problem with provisional tax is that the IRD estimates it, based on what you earned last year. However, if your income drops, or you have a slow few months, you will be paying a disproportionately high amount of tax. And no one wants to pay tax on money they haven’t even earned.
To solve this problem Solo calculates your provisional tax live so that you only pay tax on the money you have actually earned – rather than paying based on an estimate.
Solo’s approach is similar to the Accounting income method (AIM) in that it calculates your provisional tax as you go. But unlike AIM, you don’t need to file additional paperwork every two months and you still have the flexibility to pay provisional tax 4-monthly or 6-monthly.
Solo’s unique approach to provisional tax means you only pay tax on what you earn, while maintaining flexibility and reducing paperwork. You’ll love it.
Try Solo for free today and experience a streamlined, stress-free approach to managing your business finances.
Paying provisional tax is a part of being a responsible sole trader. By understanding and planning for these payments, you can avoid financial stress and focus on growing your business. Remember, you’re not alone. Tools like Solo make managing provisional tax straightforward and stress-free.