Income tax
Income tax
Income tax is a tax on the taxable income of individuals, companies and other entities, calculated each year after deducting allowable expenses from assessable income.
Income tax is the tax the Australian Government charges on the income earned by individuals, companies, trusts and other entities. It is administered by the ATO and is the largest source of revenue for the Commonwealth. It is a direct tax, meaning it is charged to the person who earns the income, in contrast to GST, which is an indirect tax collected through the sale of goods and services.
The basic calculation starts with your assessable income, which includes salary, business income, interest, dividends, rent and net capital gains. From that you subtract your allowable deductions to arrive at taxable income. Tax is then calculated on the taxable income using the relevant rates. For an individual who is a resident, rates increase as income rises, and the tax-free threshold applies. For companies, a flat rate applies depending on whether the company is a base rate entity.
After the tax is worked out, tax offsets are subtracted. Credits for tax already paid, such as PAYG withholding from wages and PAYG instalments, are also taken off. If you have paid more than you owe, you get a refund. If you have paid less, you have a tax debt to pay by the date shown on your notice of assessment. Individuals may also owe the Medicare levy, which is generally 2% of taxable income.
The Australian income year runs from 1 July to 30 June, and most individuals lodge a return after the end of the year. Businesses and registered tax agents may have different lodgment dates. Income tax is self-assessed in practice, which means you are responsible for reporting your income correctly, and the ATO then issues an assessment based on what you reported.
Income tax and GST are separate systems that happen to interact in a business. GST you collect is not your income, and GST credits you claim are not deductions. Instead, income and expenses are normally recorded excluding GST if you are registered. If you are not registered for GST, the full GST-inclusive amounts form your income and deductible costs. Getting this right is a common source of mistakes.
A common misunderstanding is that a higher tax bracket means all your income is taxed at the higher rate. In fact only the portion of income within each bracket is taxed at that bracket's rate. Rates and thresholds change, so check the ATO website for the current figures. This entry is general information only, so confirm your situation with the ATO or a registered tax professional.
Worked example
A sole trader earns $120,000 of business income in a year and has $30,000 of allowable deductions. Taxable income is $120,000 - $30,000 = $90,000. Tax is worked out on $90,000 using the current resident rates set by the ATO. She then subtracts any tax offsets and PAYG instalments already paid, and the remainder is either payable to the ATO or refunded.
Practical tips
- Remember that only the part of income in each bracket is taxed at that rate, not your whole income.
- Record income and expenses excluding GST if you are registered, since GST is handled on the BAS.
- Check the ATO website for current rates and thresholds, as these change and are set by legislation.