PAYG Instalments for Sole Traders: What They Are, How They Work, and How to Pay

One of the shocks of the first few years in business is the end-of-year tax bill. You've been earning income, paying yourself, living your life — and then your tax return comes back with a $12,000 liability you weren't expecting.

PAYG instalments exist to prevent exactly this problem. They spread your income tax payments across the year so you don't face a lump sum in November. Understanding how they work means fewer surprises, better cash flow planning, and no penalty for getting caught short.

Quick answer: PAYG instalments are quarterly pre-payments of your expected income tax, made through your BAS. The ATO usually enrols you automatically when your tax bill from business or investment income exceeds $4,000. You pay either a fixed amount or apply an ATO-set rate to your actual quarterly income. You can vary if your income changes.

This is general information, not tax advice — see your registered tax agent for your specific situation.

Source: ato.gov.au — PAYG instalments

What PAYG Instalments Actually Are

PAYG stands for Pay As You Go. The instalment system is the ATO's mechanism for collecting income tax progressively through the year rather than in one lump sum at return time.

As an employee, your employer handles this — they withhold tax from your wages and send it to the ATO each pay cycle. As a sole trader, there's no employer doing that for you. Your income tax is calculated once a year when you lodge your return. Without any pre-payment mechanism, you could end up with a large liability months after you earned the money.

PAYG instalments are that pre-payment mechanism.

PAYG Instalments vs PAYG Withholding

These sound similar but are completely different:

PAYG instalments — pre-payments of your own income tax on business and investment income. Lodged via your BAS. Applies to self-employed individuals.

PAYG withholding — tax you withhold from employees' wages and remit to the ATO. If you have employees, you run PAYG withholding on top of your own PAYG instalments. They appear in different sections of your BAS.

The two systems don't interact with each other from a sole trader perspective.

When Does the ATO Enrol You?

The ATO enrols you in PAYG instalments automatically when certain conditions are met. The general trigger is when the tax payable on your business and investment income in your most recent tax return exceeded $4,000, and your total income from those sources was more than $1.

You don't apply to be enrolled. The ATO sends you a notification (usually in your myGov inbox or by post if that's how you receive correspondence) stating you've been enrolled and your instalment amount or rate.

You're likely to be enrolled after:

  • Your first full year of running a profitable business
  • A year in which investment income (dividends, rent) was significant

If you expect your income to be above the threshold this year but you haven't been enrolled yet, you can voluntarily enter the PAYG instalment system. Ask your tax agent or check myGov.

Two Ways to Pay

Once enrolled, you have two options each quarter.

Option 1: Instalment Amount (T7 on your BAS)

The ATO calculates a fixed dollar amount based on your previous year's tax liability and notifies you. You pay that amount each quarter. Simple.

Pros: No calculations needed each quarter, predictable. Cons: If your income drops, you may be overpaying — you'll only get a refund at tax time.

Option 2: Instalment Rate (T1 and T2 on your BAS)

The ATO gives you an instalment rate (a percentage). Each quarter, you:

  1. Enter your actual instalment income (your business and investment income for the quarter)
  2. Apply the rate
  3. Pay the result

Pros: Tracks your actual income, so if you have a slow quarter you pay less. Cons: Requires more attention — you need to know your quarterly income and apply the rate correctly.

Which method suits you depends on how consistent your income is. Variable income? The rate method means you're not over-paying in slow periods. Stable income? The instalment amount method is set-and-forget.

Real Example: Jenny the Graphic Designer

Jenny is a freelance graphic designer. In the 2024-25 financial year, she earned $65,000 and had a total tax liability of $14,000 at return time.

The ATO reviews her return and enrols her in PAYG instalments for 2025-26. Her instalment amount is set at $3,500 per quarter ($14,000 / 4).

Each quarter when she lodges her BAS:

  • She enters $3,500 at T7
  • This is added to any GST owing (or offset against GST credits)
  • She pays the total BAS amount by the due date

At the end of 2025-26, she lodges her annual tax return. If she earned $68,000 and owes $15,200 in tax:

  • She's already pre-paid $14,000 (4 × $3,500)
  • Her remaining liability at return time is $1,200

If she'd earned less than last year and owes only $12,000 in tax:

  • She's pre-paid $14,000
  • She gets a $2,000 refund when her return is processed

The instalment amount was an estimate. The return squares it up.

How to Vary Your Instalment

If your income drops materially compared to last year, you don't have to keep paying the ATO's pre-calculated amount. You can vary your PAYG instalment down.

How to vary: On each quarterly BAS, there's an option to vary the instalment amount or rate. You enter the amount you think is appropriate based on your expected annual income.

The 15% rule: If you vary down and your actual tax liability at the end of the year turns out to be more than 15% higher than what you paid via instalments, the ATO can impose a penalty. This is designed to prevent people from varying down as a cash flow tactic when they fully expect a large tax bill.

Varying up is also allowed — if you've had a great year and want to reduce the end-of-year payment, you can increase your instalments.

The practical rule: Vary if your income has genuinely changed. Don't vary as a free loan from the ATO. If you're unsure, talk to your tax agent before varying.

Where PAYG Instalments Appear on Your BAS

If you're GST-registered and paying PAYG instalments, your BAS has two main sections:

GST section (G fields): GST collected, input tax credits, net GST.

PAYG instalment section (T or W fields):

  • T7: Your PAYG instalment amount (if using the amount method)
  • T1 and T2: Your instalment income and calculated instalment (if using the rate method)
  • T8 and T9: Variation fields if you're changing the amount

Your total BAS payment is GST owing plus PAYG instalment amount. If you have employees with PAYG withholding, that adds another component (W fields).

What Happens If You Ignore PAYG Instalments?

Failing to pay PAYG instalments results in:

General Interest Charge (GIC): Interest accrues on unpaid amounts from the due date. The GIC rate changes quarterly — see ato.gov.au for the current rate.

Failure to Lodge (FTL) penalty: If you don't lodge your BAS at all, you face an FTL penalty.

No reduction in end-of-year liability: Not paying your PAYG instalments doesn't mean you owe less tax — it just means you've deferred it and will now pay GIC on top.

If you genuinely can't pay, lodge the BAS and call the ATO to arrange a payment plan. They have formal hardship provisions.

When PAYG Instalments Stop

You stop being required to pay PAYG instalments when:

  • Your most recent return shows no tax on business/investment income (e.g., you had a loss year)
  • The ATO determines you no longer meet the enrolment threshold
  • You voluntarily exit the system (only in limited circumstances — check with the ATO)

The ATO notifies you if you're removed from the system. If you stop getting instalments on your BAS, it's usually because they've concluded you no longer owe significant tax — but confirm this rather than assuming.

Planning Your Cash Flow

The practical insight: treat PAYG instalments as a mandatory quarterly bill, like super or BAS. Don't spend the money they represent.

A simple approach for sole traders:

  • Set aside 30% of every invoice payment into a separate savings account
  • That covers both GST (if applicable) and income tax
  • Your quarterly BAS payments (GST + PAYG instalment) come from that account
  • What's left after June 30 is either your refund buffer or your peace of mind

Tools That Make This Easier

The messy part of PAYG instalments is knowing what your quarterly income actually is. If your books are current, you know your income the moment a quarter ends. If you're reconstructing from bank statements, you're always behind.

Summed handles BAS prep automatically — try it free for 30 days at $9/mo. Start free →

FAQ

Q: I've just started my business this year. Will I have PAYG instalments?

A: Probably not yet. The ATO typically enrols you after your first full year of trading when they can see your tax liability. Expect to be enrolled after your first full-year return is lodged and processed.

Q: I'm in PAYG instalments but I've had a terrible quarter. Can I vary to nil?

A: You can vary to a lower amount, including zero if you genuinely expect no remaining tax liability for the year. Be careful — if your liability turns out to be more than 15% above what your varied instalments add up to, you may face a penalty.

Q: My BAS due date is 28 October but I haven't received a PAYG instalment notice. Do I owe anything?

A: If you've been enrolled, the instalment amount or rate is shown on your BAS pre-fill data in the ATO's online system. If you haven't received notification of enrolment, you may not be enrolled yet. Check your myGov inbox or the ATO Business Portal.

Q: What's the difference between T7 and T2 on my BAS?

A: T7 is the instalment amount (you pay a fixed ATO-calculated number). T2 is the result of applying the instalment rate (T1 rate × instalment income). You use one approach or the other, not both. The ATO notifies you which method you're on.

Q: Can I opt out of PAYG instalments?

A: Generally not voluntarily, unless your circumstances genuinely mean you no longer meet the threshold. If you exit a business, have a loss year, or can demonstrate you won't have a significant tax liability, the ATO may remove you. Discuss with your tax agent.

Q: Do PAYG instalments cover state taxes or just federal?

A: PAYG instalments cover federal income tax only. State payroll tax (if applicable) is a separate state obligation with its own lodgment process.

Q: I vary my instalment every quarter because my income varies so much. Is that fine?

A: Yes. Varying each quarter based on realistic income expectations is exactly what the system is designed for. Keep records of your income for each quarter to support your variations.

Q: What happens to my PAYG instalments if I go on parental leave or stop earning for a while?

A: You can vary your instalment to nil for any quarter where you have no instalment income. If you expect the interruption to last more than one year, talk to the ATO or your tax agent about exiting the system.