Provisional tax is a system designed to help taxpayers who owe more than $5000 in tax at the end of the year. Here’s what you need to know.

Instead of paying a big lump sum all at once, provisional tax requires you to make smaller payments throughout the year. This helps spread out the tax burden, making it easier to manage. For businesses with a steady income, this becomes part of a regular financial routine. But if your income changes due to things like economic downturns, inflation, or events like COVID-19, it might be time to rethink how you handle your provisional tax.

Provisional tax basics

You’re considered a provisional taxpayer if you owe more than $5000 in tax. This means you must make tax payments at different times during the year — typically on 28 August, 15 January and 7 May. How much you pay depends on one of three methods:

1. Standard uplift method: This is the easiest method. You simply pay a bit more than what you paid last year, based on a percentage the tax department gives you. It’s straightforward and gives some protection if your tax bill is under $60,000.
2. Estimation method: Here, you estimate how much money you’ll make during the year and pay tax based on that estimate. This method gives you more flexibility, but you need to be accurate. If you underestimate and end up owing more, you could face penalties and interest charges.
3. Accounting income method (AIM): This method is for small businesses making less than $5 million a year. You pay tax based on your actual profit each month. It’s more accurate but requires regular reporting, and if your income swings wildly from month to month, it could put pressure on your cashflow.

Tips for managing provisional tax

Paying tax can be stressful, but you can make it easier with planning. Here are some simple tips:

1. Plan ahead: No matter your method, it’s important to plan where the money will come from to pay taxes. As a business grows, you might need to pay taxes for both past and future earnings simultaneously, so having a plan is key.
2. Keep track of finances: Regularly check your profits and keep an eye on your forecasts. This will help you figure out how much tax you need to pay and ensure you have enough money set aside.
3. Timing matters: When you file your tax return can affect when you need to pay. If you have a year with high profits, your tax bill will go up, but the next year might be more normal. Working with a tax advisor can help you time things so your cashflow doesn’t take a big hit all at once.
4. Use tax pools: Tax pools, like those offered by Tax Traders, can give you more flexibility. They let you manage your tax payments in a way that suits your cashflow, so you can still invest in your business without worrying about missing tax deadlines. Plus, they can help you avoid penalties and lower interest charges.
5. Safe harbour rule: If your tax bill is under $60,000, you’re in the “safe harbour” zone. This means you won’t be charged interest on any underpaid tax until the final payment is due, as long as you’ve made your instalments on time. If your bill is over $60,000, you can adjust your last payment to match your actual income, which helps reduce interest charges.
6. New to provisional tax?: If you’re new to this and your first-year tax bill exceeds $60,000, you’ll need to make provisional tax payments as if you were already a provisional taxpayer. This can catch people off guard, so it’s smart to talk to a tax advisor and make a plan.

In short, while paying taxes is a part of running a profitable business, managing how you pay them can make things much easier. The tax department usually expects you to pay based on last year’s earnings, but things might differ this year. Working closely with your tax advisor allows you to stay on top of your tax obligations without straining your business’s finances.

Remember, this article is just general advice. For specific help with your taxes, it’s best to talk to a professional.