Introduction
Payroll systems cannot know in advance that an employee may cease employment during a tax year, may change role and/or pay rate, or may have periods of unpaid leave for example. They must therefore assume that an employee will be employed for the entire tax year and apply the currently selected pay rates and tax scales to each payrun.
To calculate the amount of tax to withhold, each payrun will multiply the Gross earnings on that payrun by the number of pay periods in the tax year to forecast the total taxable payments for the year and determine the appropriate tax rate based on this forecast.
This means that a payrun containing higher than normal payments (e.g. extra overtime or bonuses) may be taxed at a higher than normal tax rate if the annualised Gross earnings from that payrun take the employee into a higher tax bracket.
This annualisation process does a good job of withholding an appropriate amount of tax over the year in most situations. At the end of the tax year, when the employee’s Gross earnings are finalised, the ATO income tax assessment process will calculate the final amount of tax payable for the year and the employee will receive a tax return or tax bill as appropriate.
Do I need to adjust the Tax?
A tax bill at EOY from the ATO is usually due to an employee receiving untaxed income from other sources, or larger ad hoc payments not being taxed correctly. Although the annualisation process works well on regular payments, it may not be accurate on larger and less frequent payments.
For this reason, you may need to manually adjust the amount of tax withheld on such payments.
Normal Payrun or Adjustment Payrun?
Entering an ad hoc payment, such as a large bonus, on a Normal Payrun with the employee’s regular pay will ensure that sufficient tax is withheld. If the annualised Gross earnings on that payrun takes the employee into a higher tax bracket, it is possible that more tax will be withheld than is necessary but the employee will get it back from the ATO at the end of the tax year.
Entering an ad hoc payment, such as a large bonus or cash-in of leave, on an Adjustment Payrun means the tax on that payment is calculated in isolation from the regular earnings for that pay period. This can lead to a significantly insufficient amount of tax being withheld from the ad hoc payment, unless you adjust it.
Marlin HR enables you to manually adjust the amount of tax withheld on any type of payrun and the procedure to determine the appropriate amount of tax to withhold is shown in the table below.
We recommend that you follow the procedure for all ad hoc payments, regardless of payrun type used, and especially for significant amounts.
How to calculate Tax on ad hoc payments
The most accurate method of determining the amount of tax to withhold from an ad hoc payment, is to first forecast the employee’s total normal Gross earnings for the tax year. Then add the ad hoc payment amount to produce a higher total and enter both totals into an online tax calculator to determine the tax payable on each. The difference in tax is the amount of tax attributable to the ad hoc payment.
Procedure:
In order, from A to I, follow the instruction provided to derive the required amount.
| Item | $Amount | Instruction |
|---|---|---|
| A | Run a Pay Analysis Report (on the By Employee tab select the employee and click on ALL to select all payruns this year). Enter the Total shown at the bottom of the Gross column here. | |
| B | Count the number of different Pay To dates on the report (not the number of payruns) and enter it here. | |
| C | Enter the number of pay periods in the year (eg. 52 for Weekly) | |
| D | Forecast Gross for the year (A / B * C) | |
| E | Tax payable on D (go to paycalculator.com.au , enter the amount from D as the Annual Salary, leave all default settings and grab the Tax amount from the Annually column). | |
| F | Enter the amount of the ad hoc payment here | |
| G | The new Forecast Gross for the year (D + F) | |
| H | Tax payable on G (go to paycalculator.com.au , enter the amount from G as the Annual Salary, leave all default settings and grab the Tax amount from the Annually column). | |
| I | The tax payable on the ad hoc payment (H – E) |
The amount you end up with for I is the amount of tax to withhold from the ad hoc payment.
How to apply the Tax adjustment
If there are no other payments on the payrun, enter the ad hoc payment and then adjust the Tax amount shown up or down to match the amount you calculated in I above.
If there are other payments on the payrun, enter those first and note the Tax amount displayed. Then enter the ad hoc payment and again note the Tax amount displayed. Adjust the Tax amount shown so that it matches the initial Tax amount plus the amount you calculated in I above.