As long as you’re earning income in Australia or from overseas, you’ll potentially be liable to pay income tax to the Australian Government. So, what is income tax and how much are you required to pay?
This article sets out to explain:
After the end of the financial year, you can lodge a tax return to the ATO to either get a tax refund – if you have paid more tax than required – or to pay any extra tax that you may be liable for. In this article, we cover income tax and how much you might need to pay.
What is income tax?
Income tax is a type of tax you pay to the government on the income earned from a job or your investments. It is calculated based on how much you earn within a financial year (1 July to 30 June), and any deductions or offsets you can claim.
If you are an employee, your employer will normally take your income tax out of your pay and send it to the Australian Taxation Office (ATO) on your behalf throughout the year. If you are self-employed, you will need to set this money aside and pay it yourself.
Either way, after the end of the financial year you can then lodge a tax return to the ATO to either get a tax refund (if you have paid more tax than required), or to pay any extra tax that you may be liable for.
Why do we pay income tax?
Income tax, like most taxes, is used as a form of revenue generation for governments so that they can reinvest this back into infrastructure, social security payments and public services such as health, education and defence.
Total tax savings for 2020/21
To get an idea of what kind of total tax savings taxpayers on a range of different incomes could make in 2020/21 (compared to 2017/18), the Australian Government has provided the following breakdown:
- $40,000 taxable income: $1,060 saving
- $60,000 taxable income: $2,160 saving
- $80,000 taxable income: $2,160 saving
- $100,000 taxable income: $2,445 saving
- $120,000 taxable income: $2,745 saving
- $140,000 taxable income: $2,565 saving
- $160,000 taxable income: $2,565 saving
- $180,000 taxable income: $2,565 saving
- $200,000 taxable income: $2,565 saving
These potential savings are indicative estimates for individual taxpayers in 2020/21 based on all tax relief measures in the October 2020 Budget, according to government figures. Actual outcomes for individuals and households may differ.
How much income tax do I need to pay?
To understand how much tax you may need to pay, you’ll first need to look at the current income tax brackets and rates, as listed on the ATO website. Australia has a ‘progressive’ tax system, which means that the more you earn, the more you’ll need to pay in tax.
Resident individual income tax brackets and rates
Australian residents (i.e. people who are Australian residents for tax purposes) are generally taxed on their worldwide income. Below are the income tax rates and brackets for Australian residents in the 2020/21 financial year:
Based on the Australian resident income tax rates above, if Joe, a hypothetical Australian taxpayer, earned $125,000 per year, the tax he would need to pay could be calculated like this:
You could also use a simpler equation taken from the ATO’s tax rate table above to calculate your income tax. For example, for Joe, it would be: $29,467 + ($0.37 x $5,000) = $31,317.
You can calculate your income tax manually, like we have done in the examples above, or you can use an online calculator. Calculating the income tax you are required to pay may help you check whether your employer has been withholding the right amount of tax from your pay, or if you’re self-employed it could help you understand how much income tax needs to be put aside from your pay packet.
Foreign resident individual income tax brackets and rates
To figure out whether you’re a foreign or Australian resident for tax purposes, the ATO has developed a tool that helps you to determine your residency status. According to the ATO, foreign residents for tax purposes are generally taxed only on their Australian-sourced income, such as money they earn working in Australia. The below 2020/21 tax rates apply to foreign residents earning income for tax purposes in Australia:
Working holiday maker tax brackets and rates Working holiday makers are individuals who are on the 417 or 462 subclass visas. The ATO said most working holiday makers are generally considered a foreign resident for tax purposes, which means they will only be taxed on income they have earned in Australia. The below 2020/21 tax rates apply to individuals who are earning income through a working holiday maker visa (under both visa subclasses 417 and 462):
Children’s income tax rates
If you are an Australian resident for tax purposes and are under 18 years of age, some of your income may be taxed at a higher rate than an adult, such as income earned from family trusts (a trust that holds your family assets for asset protection and income distribution). However, you pay the same individual income tax rates as an adult if you are an excepted person or earn an excepted income. For more information on children’s income tax visit the ATO website.
Budget 2020 tax cuts
The Federal Government announced a range of tax changes in the October 2020 Budget. These tax changes can be grouped into two main categories:
1. One-off tax relief
In 2020-21, low-and middle-income earners will receive one-off tax relief of up to $1,080 for singles, and up to $2,160 for dual-income families. The government has labelled this tax relief a “one-off additional benefit” on top of the existing low and middle-income tax offset (LMITO). Taxpayers who are eligible for this tax relief will receive more money in their regular pay packets because their employer will reduce the amount of tax normally taken out of their pay. This tax reduction will be applied to eligible taxpayers and backdated from July 1, 2020, through to the end of this financial year. The amount a taxpayer will save under this one-off tax relief will be dependent on their taxable income.
2. Stage 2 tax cuts
The government has also brought forward tax cuts planned for July 1, 2022, to July 1, 2020. These changes include: 1. Increasing the low-income tax offset from $445 to $700, providing an additional $255 in tax relief. 2. Increasing the top threshold of the 19% personal income tax bracket from $37,000 to $45,000 (providing up to $1,080 in tax relief). 3. Increasing the threshold of the 32.5% tax bracket from $90,000 to $120,000 (providing up to $1,350 in tax relief).
These tax cuts were backdated to July 1, 2020, and they will be passed on to eligible taxpayers through their regular pay packets.
Paying no income tax: tax-free threshold
The tax-free threshold is the amount of income earned in a financial year that isn’t taxed. For the 2020–21 financial year, the tax-free threshold is $18,200. Not all individuals can claim the tax-free threshold (such as working holiday makers), however for those that can, this means that the first $18,200 you earn in a financial year will not be taxed.
Medicare levy and surcharge
On top of paying income tax, most people will also pay a Medicare levy. This levy is charged as part of your yearly income tax assessment and is used to partially fund Medicare. If your taxable income is above a certain threshold, you will have to pay a Medicare levy of 2% of your taxable income, according to the ATO.
If your taxable income is below the threshold, your Medicare Levy is reduced. Some Australians might not have to pay the levy at all because their income is below the minimum threshold. You can find out what Medicare levy you may be required to pay with the ATO’s Medicare Levy Calculator.
The ATO said generally the pay as you go tax amount your employer withholds from your salary or wages includes an amount to cover the Medicare levy. Your actual Medicare levy is then calculated by the ATO when you lodge your income tax return.
In addition to the Medicare levy, you may also have to pay the Medicare levy surcharge (MLS) if you don’t have a certain level of private patient hospital cover and earn above $90,000 if you’re single or $180,000 as a family. The MLS is a percentage of your income that will be payable to the ATO when you lodge your tax return.
What income is taxable?
If you are an Australian resident for tax purposes, the income you earn worldwide (Australia and overseas) from the below list that exceeds the tax-free threshold (of $18,200) can be taxed regardless of whether it’s paid in cash, cheque or electronically:
- Salary and wages
- Tips and gratuities
- Interest from bank accounts
- Work allowances, such as for travel, clothing, laundry and your vehicle
- Dividends and capital gains from your investments
- Bonuses
- Overtime payments
- Commissions
- Pensions
- Rent
What income is not taxable?
While the majority of income earned above the tax-free threshold (of $18,200) is generally taxable, there is a small group of payments (predominantly government payments) that is non-taxable. Some examples could include:
- Certain government pensions, such as the disability support pension
- Certain government allowances, such as the carer allowance and child care subsidy
- Certain overseas payments and allowances for Australian Defence Force and Federal Police employees
- Government education payments for students under 16 years of age
- Certain scholarships, grants or awards
- Payments received from an insurance policy payout where the policy is under your name and are not earned, expected, relied upon or occur regularly, such as mortgage protection, terminal illness or permanent injury suffered at work
- Rewards or gifts for special occasions, like birthday presents
- Prizes won on game shows or lottery winnings
- Child support and spouse maintenance payments
- Government super co-contributions
How to reduce your taxable income
There are several ways you can potentially reduce the amount of income tax you pay each financial year, such as through claiming tax deductions or certain tax offsets that you may be eligible for, or choosing to salary package (salary sacrifice) your earnings.
1. Tax deductions
Tax deductions are claims that are made, usually in the form of a related expense, to help you reduce your taxable income. Tax deductions can range from work-related expenses to investment-related expenses, which may help to offset any income earned from your job or investment assets. For example, depending on your circumstances you may be able to claim on laundry and self-education costs related to earning your income or on depreciation for your investment property to lower your taxable income. Tax depreciation is a type of tax deduction claimed on the natural wear and tear of an asset that produces income for you. For example, a rental property. To further explain how tax deductions can be used to reduce your taxable income, let’s use a hypothetical example.
Joe earns $125,000 (his assessable income) in the 2020/21 financial year from his job and rental investment property. During that year, he incurs the following costs which he found he can claim as deductions on his tax return:
- $500 on laundry costs (he wears a uniform for his work)
- $1,500 on a course related to his job
- $7,500 on tax depreciation expenses for his rental property
- $9,000 in interest on his home loan
Taking the total of these deductions ($500+$1,500+$7,500+$9,000 = $18,500 ) from his assessable income, you can get his taxable income: $125,000–$18,500 = $106,500 Now with his taxable income, Joe can then work out how much tax he is required to pay using the income tax rates for an Australian resident:
This means that Joe’s total income tax for the year, with deductions included, would be $27,679.50.
Now let’s work out what Joe’s tax payable would be if he hadn’t claimed these deductions. As there are no deductions to subtract, his taxable income is $125,000, the same as his assessable income of $125,000. As he is still in the $120,000 to $180,000 marginal tax bracket, the calculations apply as per the earlier examples above. Therefore Joe’s total tax payable without deductions would be $31,317.
Comparing the two scenarios, we can see that Joe’s tax payable has been reduced by $3,637.50 by claiming deductions.
Bear in mind that it’s important to only claim tax deductions you’re legally entitled to. Generally speaking, the expenses have to be related to your work or the income you earn during the year. It could be worth speaking to a qualified accountant or tax adviser for assistance.
2. Tax offsets
Tax offsets, also known as tax rebates, can also be used to reduce your taxable income if you meet certain eligibility requirements. They are applied after the tax has been calculated. Common tax offsets may include those for:
- Low-income and middle-income earners
- Taxpayers who are supporting an invalid relative
- Pensioners and seniors
- The taxable portion of your income from superannuation
You may also be eligible for a private health insurance rebate or tax offset if you have a complying policy.
3. Salary packaging
Salary packaging (also known as salary sacrificing) is when you arrange to receive less income after-tax, in return for your employer paying for you to receive benefits out of your pre-tax salary. These benefits may go towards car payments or your superannuation, for example. If you reduce your salary in this way, you will also be reducing your taxable income, which could lead to you paying less tax overall.
Key takeaways
While earning more money will essentially mean you pay a higher tax bill, there are ways you can potentially reduce your taxable income each year, such as those listed above. However, as the rules surrounding tax deductions and offsets can be complex, it may be worth considering getting professional tax advice from an experienced accountant to help you legally minimise your tax liability.
If you knowingly claim a tax deduction or offset that you are not entitled to, or provide false or misleading information in your tax return, the ATO said you may face serious consequences, including a penalty, criminal conviction, fine and prison sentence.
You can find further information regarding income tax, and the current income tax rates, through the ATO and Moneysmart websites.
Please note: The examples provided in this article are not based on actual products or real consumer circumstances.
