Ngā Pūtaketanga Pakihi - Moniwhiwhi me te tāke utu tōmua Income and provisional tax

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The video title Business Basics Income and provisional tax slides in from the left.

The title slides to the right of the screen and is replaced by a person sitting at a desk with a laptop. File folders, a desk lamp and a mug also appear on the table. A clock ticks on the wall. 3 lights hang from the roof and there is a potted plant on both sides of the desk.

Two circles appear above the person’s head, 1 has a “Income tax” in the middle of it, the other has “Provisional tax”.

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Easy listening style music plays throughout the entire video.

Narrator

Are you in business for yourself?

In this video we’ll explain how income tax works.

You'll also find out if you have to pay provisional tax, a way of paying your income tax throughout the year.

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Carolyn appears with a camera in her hand and photography equipment surrounds her.

A circle appears with $98,000 inside it, the figure is then replaced by an Income tax return. Two circles with dollar symbols appear on the tax return, 1 is smooth and represents gross income, the other is spikey and represents expenses. The expenses are removed from the gross income. Expenses of $32,000 are deducted from the gross income of $98,000, leaving a total net profit of $66,000.

$98,000 turns into “Net profit” and 2 more circles appear, 1 has “salary” in it, the other “wage” showing these are included in your net profit.

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Narrator

Meet Carolyn, she's a photographer who's just started working for herself as a sole trader.

In her first year, Carolyn made gross sales of 98,000 dollars.

Regardless of what business structure is chosen, when you file your income tax return, you record your gross sales then deduct your business expenses.

Carolyn's business expenses for the year came to 32,000 dollars.

After deducting her expenses, Carolyn has made a net profit of 66,000 dollars.

You only pay income tax on your taxable income, that’s your net profit plus any other income you might earn like a salary or wage.

Let's see what this means for Carolyn as a sole trader.

Visual

Carolyn stands next to a graph which ranges from $0 to $66,000. The graph is separated into 3 income tax bands:

1. Income between $0 and $14,000.
   In this band the tax rate of 10.5%, and $1,470 (the tax on the first $14,000 of income) are shown.
2. $14,001 to $48,000.
   In this band the tax rate of 17.5%, and $5,950 (the tax on the next $33,000 of Carolyn’s income) are shown.
3. $48,001 to $66,000.
   In this band the tax rate of 30%, and $5,400 (the tax on the last $18,000 of Carolyn’s income) are shown.

Carolyn’s total income tax for the year of $12,820 is shown.

Carolyn is replaced by an image of a building, and the graph only has 1 band between $0 and $66,000. The tax rate of 28% is shown, which is the flat tax rate for companies. The total income tax for the year of $18,480 is shown.

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Narrator

Carolyn’s taxable income is split into portions taxed at different rates.

The first 14,000 dollars of her 66,000 dollar taxable income is taxed at 10.5%, so she'll pay tax of 1,470 dollars on this part of her income.

Income from 14,001 dollars to 48,000 dollars is taxed at 17.5%.

Carolyn has about $34,000 here so she’ll pay tax of about 5,950 dollars on this part of her income.

The remaining income 48,001 dollars to 66,000 dollars is taxed at 30%.

Carolyn has about 18,000 dollars here so she pays about 5,400 on this part of her income.

Carolyn's total income tax for the year is 12,820 dollars.

That's how income tax works for sole traders.

For companies, it's a bit different.

A company's taxable income is taxed at a flat rate of 28%.

This would work out to be 18,480 dollars in this example, thousands more than what Carolyn pays as a sole trader.

So that's income tax, now let's look at provisional tax.

Visual

A horizontal timeline is shown and separated into 3 segments. A circle with a dollar symbol appears in each segment indicating 3 provisional tax payments. The circles merge together and grow in size, then slide to the right beyond the timeline. This shows how it is easier to pay tax in smaller instalments rather than 1 big bill.

A calendar appears and flicks back from 2019, to 2018, and 2017 before disappearing.

A circle with a question mark appears to ask who has to pay provisional tax. An Income tax return appears to the right of the circle, showing anyone with tax to pay of more than $5,000, after tax credits are deducted from your net proft, has to pay provisional tax the following year.

The question mark is replaced by “Standard option”. A new circle with “Estimation option” slides to the right from behind the first circle. These are the 2 main ways to calculate provisional tax.

A new circle appears on the left with “Accounting Income Method” in it. The words are replaced by a laptop showing a profit and loss graph indicating provisional tax is only paid when a profit is made.

A new circle appears on the right with “GST ratio option” in it. The words are replaced by a laptop showing 2 circles with dollar symbols in them. The circles merge to form a sun suggesting seasonal income during warmer months.

Our web address, ird.govt.nz, slides from left to right.

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Narrator

Provisional tax isn’t a separate tax, it’s a way of paying your income tax throughout the year, usually across 3 instalments.

Provisional tax helps you spread the load rather than paying all your income tax in one go.

The amount you pay is generally based on earlier years.

Who has to pay provisional tax?

Anyone who has tax to pay of more than 5,000 dollars at the end of the tax year after subtracting most types of tax credits.

There are 2 main ways to calculate provisional tax.

The standard option, and the estimation option.

There’s also the Accounting Income Method, also known as AIM.

It’s the provisional tax option that uses accounting software to work out your payments throughout the year so you only pay tax when you make a profit.

And there’s the ratio option which lets you match your provisional tax payments with your business cashflow, which is useful if your income varies or you have seasonal income.

Go to ird.govt.nz to learn more about the standard option, estimation option, AIM, and the ratio option.

Visual

The standard option circle grows, a calendar displaying “Previous year” and “+5%” are shown.

Carolyn appears on the right of the screen with her camera. The equation working out Carolyn’s provisional tax for the following year is displayed. $12,820 + 5% = $13,461.

A timeline is shown under the equation, split into 3 segments. The total provisional tax is then divided by 3 to get the instalment for each provisional tax payment and $4,487 is shown in each segment of the timeline.

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Narrator

If you choose the standard option, your provisional tax equals your previous year's income tax plus 5%.

Here’s an example of calculating your provisional tax using the standard option.

Carolyn's income tax payable was 12,820 dollars so her provisional tax for this second year is 5% more, 13,461 dollars.

She divides by 3 to give the amount of each instalment.

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The estimation option circle replaces the standard option circle. A baby appears in Carolyn’s arms and a new circle with a downward arrow is shown indicating Carolyn will be spending less time on her business next year. The downward arrow is replaced by a dollar symbol and then a calculator.

Carolyn’s estimated income for her 2nd year of $36,000 is displayed. The total tax to pay of $5,320 is shown under the total income. A horizontal timeline is shown and separated into 3 segments. A circle with a dollar symbol appears in each segment indicating 3 provisional tax payments. The first 2 segments display provisional tax instalment payments of $1,773, and the 3rd segment shows $1,774.

The 4 provisional tax options are shown again, Accounting Income Method, standard option, estimation option, and GST ratio option. An exclamation mark is shown to make sure you know to be careful with using the estimation option as penalties and interest can be charged if the estimate is too low.

The ratio option circle pulses and a new circle pops up from behind it with “Must be GST registered” in it.

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Narrator

If you think your income for the coming year will drop and you don’t want to overpay, you might choose the estimation option instead.

Suppose Carolyn has a baby and she plans to spend less time working in her business during her second year.

She expects her income will drop as a result, so she chooses the estimation method to calculate her provisional tax after preparing a budget.

Carolyn works out her taxable income for year 2 will be 36,000 dollars.

Tax on 36,000 dollars is 5,320 dollars.

Carolyn divides by 3 and sees that for her second year of business she'll need to pay 3 provisional tax instalments. Two provisional tax instalments of 1,773 dollars and 1 instalment of 1,774 dollars.

Estimate your provisional tax carefully.

Interest and penalties may be charged if your estimate is too low.

As mentioned earlier, the ratio option is useful if your income varies or you have seasonal income.

Visual

Crosses appear in the standard option, estimation option, and GST ratio option circles as you generally do not need to pay provisional tax in your first year of business. A dollar symbol and upward arrow appear in the Accounting Income Method circle as you may pay provisional tax in your first year if you make a profit.

The scene is split into 2 with year 1 on the left and year 2 on the right. A circle with year 1 tax return is shown in year 1. A calendar showing 7 February is displayed in year 2 indicating this is when the tax for year 1 is usually due to be paid. The year 1 tax return moves to year 2 showing year 1 tax and year 2 provisional tax are being paid in the same year. A big tick appears on the screen as making sure you budget for these payments will help you get tax right from the start.

The year 1 tax return moves back to the year 1 side of the screen, it leaves behind small circles with dollar symbols in them indicating voluntary tax payments are a great way to help ease the pressure of a big tax bill.

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Narrator

When do you pay provisional tax in instalments?

Paying tax in your first year of business is a bit different.

If you use the standard, estimation or ratio options, you will not need to pay provisional tax during your first year of business.

If you use the accounting income method, or AIM, you’ll only pay provisional tax when you make a profit, even during your first year.

That’s not to say your first year in business is tax free.

Any income tax for your first year in business is usually due by 7 February in your second year of business.

So you could be paying income tax for your first year of business while also having to pay provisional tax for your second year of business.

This is why it’s important to budget for tax right from the start.

To help spread the cost, you can choose to make voluntary payments of tax during your first year of business, you might even be able to get an early payment discount if you do this.

Visual

A timeline is displayed, starting with the end of the first tax year on 31 March. The provisional tax instalment due dates are then displayed on the timeline:

1. 28 August.
2. 15 January.
3. 7 May.

A circle with a dollar sign appears from behind each provisional tax payment date to show that Carolyn budgeted for her payments. A big exclamation mark is shown as interest and penalties may be charged if a payment is not made in full or on time.

The exclamation mark is replaced by an envelope as you should contact us before the payment due date if you know you’re going to struggle meeting a payment.

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Narrator

Let's look at a timeline for instalment payments from your second year onwards.

If you have the standard balance date of thirty-first of March, your first instalment each year must be paid by the twenty-eighth of August, your second by the fifteenth of January and your third and final by the seventh of May.

Please include your provisional tax payments in your budget so you can pay in full and on time.

Interest and penalties may be charged on any late payments.

If you’re anticipating difficulty paying, contact us before the due date.

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Two laptops appear. One has business.govt.nz on it, the other ird.govt.nz

The video ends with the Inland Revenue Te Tari Taake logo.

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Narrator

Wrapping up, for useful tools and resources for business, visit business.govt.nz

Visit our website, ird.govt.nz for more information on income tax and provisional tax