Kellett Accounting Solutions Limited
Tax specialists for network marketing and home based business professionals
The many faces of Income Tax
Income tax is quite simply tax you pay on your income. However, it appears in many different forms, which can be quite confusing.
Basically, you add all your sources of income and subtract any tax deductible expenses and any losses (from other taxpayers or brought forward from a previous year) to figure out your taxable income. This is multiplied by your tax rate (or, for an individual taxpayer, rates) to give your income tax payable for the year.
However, most people don't have to pay the full amount of this income tax payable, as they have paid some of this tax during the year. In fact, many people may actually receive a refund (if the tax paid during the year is more than the tax payable).
Tax paid during the year takes three main forms.
Since PAYE, WT, RWT and NRWT are all calculated for you, there's not too much to do with regard to those, other than making sure that you're being taxed at the right rate (for PAYE, check your tax code).
There are three ways to calculate provisional tax.
Firstly, you can make an estimate of what you think your tax position will be and pay based on that. If your estimate is too high and you overpay your tax, you're fine, and may even be paid some interest on the excess. Less positively, if you underestimate and underpay, you'll be charged interest (at a higher rate) on the shortfall.
The second, "standard" method for calculating provisional (prov) tax is to pay the tax on 105% of your prior year's taxes (or 110% of the year before, if the prior year's return isn't filed when the payment is due). There are two advantages to this method; it's very simple (your accountant will be able to tell you the numbers easily) and, even if you end up having paid too little tax, in most cases, you won't have to pay any interest (this may not be the case if the amount of tax is significantly underpaid, or if the taxpayer is a company rather than an individual).
The final way of calculating prov tax is the "ratio" method, which allows you to pay your provisional tax based on a calculation driven by the income from your GST returns. This is ideal for taxpayers whose income is very unpredictable or cyclical; if you have very little income in a GST period, you'll pay very little prov tax too. This option is only available to taxpayers who have paid GST on a monthly or two-monthly basis for all of the last year, and have been in business for more than 12 months.
Hopefully the information above has given a bit more clarity to the various guises income tax takes, and how it might impact on you.
If you have a business that you think is profitable, it's worth putting aside some money to cover your taxes so that when tax time does roll around, it's not such a shock. A future article will discuss how to figure out much you need to put aside.
Basically, you add all your sources of income and subtract any tax deductible expenses and any losses (from other taxpayers or brought forward from a previous year) to figure out your taxable income. This is multiplied by your tax rate (or, for an individual taxpayer, rates) to give your income tax payable for the year.
However, most people don't have to pay the full amount of this income tax payable, as they have paid some of this tax during the year. In fact, many people may actually receive a refund (if the tax paid during the year is more than the tax payable).
Tax paid during the year takes three main forms.
- Pay As You Earn (PAYE) or Withholding Tax (WT): These taxes are deducted from your salary and wages (or contractor payments for WT) by your employer before you receive your money, and are then paid to the IRD each month.
- Resident Withholding Tax (RWT) or Non Resident Withholding Tax (NRWT) on interest: before you receive interest income, most entities withhold a percentage of the income, which is again passed on to the IRD.
- Provisional Tax: This is a tax that you have to pay direct to the IRD. It applies only to taxpayers who are expected to have an income tax bill (after deducting any other tax paid during the year) of more than $2,500. The intention of this is just to spread the burden of paying your tax so that the final payment on 7 April (or 7 February if you don't have a tax agent) isn't quite such a shock to the cashflow. However, since the payments (2 or 3 depending on how frequently you file your GST Returns) are actually in advance, many people find it quite frustrating.
Since PAYE, WT, RWT and NRWT are all calculated for you, there's not too much to do with regard to those, other than making sure that you're being taxed at the right rate (for PAYE, check your tax code).
There are three ways to calculate provisional tax.
Firstly, you can make an estimate of what you think your tax position will be and pay based on that. If your estimate is too high and you overpay your tax, you're fine, and may even be paid some interest on the excess. Less positively, if you underestimate and underpay, you'll be charged interest (at a higher rate) on the shortfall.
The second, "standard" method for calculating provisional (prov) tax is to pay the tax on 105% of your prior year's taxes (or 110% of the year before, if the prior year's return isn't filed when the payment is due). There are two advantages to this method; it's very simple (your accountant will be able to tell you the numbers easily) and, even if you end up having paid too little tax, in most cases, you won't have to pay any interest (this may not be the case if the amount of tax is significantly underpaid, or if the taxpayer is a company rather than an individual).
The final way of calculating prov tax is the "ratio" method, which allows you to pay your provisional tax based on a calculation driven by the income from your GST returns. This is ideal for taxpayers whose income is very unpredictable or cyclical; if you have very little income in a GST period, you'll pay very little prov tax too. This option is only available to taxpayers who have paid GST on a monthly or two-monthly basis for all of the last year, and have been in business for more than 12 months.
Hopefully the information above has given a bit more clarity to the various guises income tax takes, and how it might impact on you.
If you have a business that you think is profitable, it's worth putting aside some money to cover your taxes so that when tax time does roll around, it's not such a shock. A future article will discuss how to figure out much you need to put aside.