How does a tax refund or tax payable happen?
The basic income tax refund formula is:
Tax withheld less tax payable = income tax refund.
Example:
John’s employer withholds $32,000 of tax from his pay.
John’s income tax payable is $30,000.
John’s tax refund is tax withheld ($32,000) less income tax payable ($30,000) = $2,000
The amount of tax withheld (PAYG Withholding) by an employer usually affects the size of a tax refund more than tax deductions. Why? Because every dollar of tax withheld affects the size of the refund by a dollar, the value of tax deductions depends on the tax rate.
The reason why a tax refund can be lower than expected (potentially even resulting in tax payable) is that employer(s) don’t withhold enough tax from your pay. This is not uncommon. There are several reasons why this can happen:
- The tax free threshold is claimed for more than one job during the financial year;
- Any variation in pay such as bonuses or commissions or HECS deductions;
- Payroll system errors.
First of all, it is important to understand that the “tax” withheld from your pay by your employer is only an estimate of the tax you will owe the government. The actual tax you owe the government can only be accurately calculated once the financial year has ended and your total income and expenses have been taken into account.
For example, you may stop working halfway through the year. The tax withheld by your employer is likely to be significantly higher than the tax you owe the government. This is because the employer was withholding at a higher rate, assuming that you would be working the full year and therefore earning a higher income than you did.
Or, you may have more than one job during the financial year. The tax withheld by other employer(s) is likely to be lower than the tax you owe the government. This is because as your earn more, your tax payable rate gradually increases. However, your other employer is usually not aware of your other income. So they will withhold tax based on only the income you earn from them. Which is lower than your tax on the total income for the financial year.
Tax free threshold
There is effectively no tax payable on the first $21,880 of income you earn. Even though the official tax-free threshold is $18,200, the Low Income Tax Offset (LITO) has the effect of increasing the minimum taxable income taxing point for most lower income earners.
As you earn income above that, however, the tax payable rate increases. When you start working with an employer, they need to decide how much money to withhold from your pay to meet your tax liability to the government. Usually, an employer will give you a tax file number declaration form to complete. The form asks if you wish to claim the tax free threshold. If you only have one employer for the whole financial year, you should claim the tax free threshold. If you have more than one job, you should not claim the tax free threshold for any other jobs. Otherwise, that is essentially telling your other employers to withhold very little or no tax from your pay. In other words, you can’t have more than one $21,880 tax free threshold.
Variation in pay
If you receive bonuses, commissions, or there are any other variations in your pay, this can result in insufficient tax being withheld. Receiving more income may raise your tax rate. Yet the payroll software might not deduct more tax, causing a shortfall in tax withheld.
Payroll system errors
Payroll systems are not set up the same in every business. Some payroll systems withhold more tax, while others withhold less. A larger amount of tax withheld will result in less take-home pay during the year but a larger tax refund. A smaller amount of tax withheld will result in more take-home pay during the year but a small tax refund (or a tax bill).
