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 one large bill after you lodge your return. 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 automatically enrols individuals (including sole traders) when their latest return shows instalment income of $4,000 or more, their latest notice of assessment shows tax payable of $1,000 or more, and their estimated (notional) tax is $500 or more. You pay either a fixed amount or apply an ATO-set rate to your actual quarterly income. You can vary if your income changes — but if your varied instalments add up to less than 85% of your actual tax on instalment income for the year, the ATO may charge general interest charge on the shortfall.

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 individuals (including sole traders) in PAYG instalments automatically when all three of these apply: instalment income (gross business and investment income, excluding GST and capital gains) on your latest tax return of $4,000 or more, tax payable on your latest notice of assessment of $1,000 or more, and estimated (notional) tax of $500 or more. Different thresholds apply to companies and super funds — see ATO — Starting PAYG instalments for the current full list of triggers.

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, if you're eligible for both options, you choose one on your first activity statement of the income year and keep it for the rest of that year. You can switch at the start of the next year.

Option 1: Instalment Amount (T7 on your BAS)

The ATO calculates a fixed dollar amount from your most recent tax return, adjusted upward by a GDP adjustment factor to allow for income growth, and shows it on your activity statement or instalment notice. 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. Her 2025-26 tax return shows $14,000 of tax on her business income.

The ATO reviews her return and enrols her in PAYG instalments for 2026-27. Her quarterly instalment amount is based on that $14,000 plus the ATO's GDP adjustment. To keep the numbers simple, say it comes to $3,500 per quarter.

Each quarter when she lodges her BAS:

  • Her $3,500 instalment amount is shown at T7 on her BAS
  • 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 2026-27, she lodges her annual tax return. If her tax for the year comes to $15,200:

  • 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 85% rule: If you vary and your varied instalments for the year add up to less than 85% of your actual tax on instalment income, the ATO may charge general interest charge (GIC) on the difference. Depending on the circumstances, penalties may also apply. 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 fields):

  • T7: Your PAYG instalment amount (if using the amount method)
  • T1 and T2: your instalment income (T1) and the ATO's instalment rate (T2) if you use the rate method. Multiply T1 by T2 to get the amount you pay.
  • T8 and T9 (amount method) or T3 (rate method), plus T4 (reason code): the fields you use if you vary your instalment

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. GIC incurred from 1 July 2025 is also no longer tax-deductible.

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 latest return or assessment puts you below the thresholds. For individuals, that means, for example, instalment income under $4,000, a tax debt under $1,000 (after instalments), estimated (notional) tax under $500, or a calculated instalment rate of 0% (which can happen in a loss year)
  • The ATO determines you no longer meet the enrolment threshold
  • You ask to exit because you're no longer earning business or investment income (through myGov or your tax agent)

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 common cash-flow approach used by sole traders is to set aside a fixed percentage of every invoice payment into a separate savings account to cover quarterly BAS, PAYG instalments and end-of-year tax. The right percentage depends on your GST registration status, marginal bracket and PAYG instalment amount — your registered tax agent can model the right number for your business. Whatever percentage you choose, treating the set-aside as untouchable until BAS or tax time is the discipline that prevents end-of-year shortfalls.

This is general information, not tax advice. PAYG instalment thresholds, rates and variation rules change. Whether and how to vary your instalments — and what cash-flow buffer is right for your business — depends on your specific income, deductions and tax position. Speak to a registered tax agent before varying or before relying on the worked examples in this article.

Tools That Make This Easier

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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 varied instalments add up to less than 85% of your actual tax on instalment income for the year, you may be charged GIC (and possibly penalties).

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 Online services for business.

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 instalment rate the ATO gives you: you multiply your instalment income at T1 by the T2 rate to work out what to pay. You use one approach or the other, not both. If you're eligible for both, you choose on your first activity statement of the income year and stay with that option for the rest of the year.

Q: Can I opt out of PAYG instalments?

A: You can ask to exit if you're no longer earning business or investment income, through myGov (Tax > Manage > Tax registrations > Cancel) or your tax agent. Otherwise, the ATO removes you automatically once your latest return puts you below the thresholds (for individuals, for example, instalment income under $4,000 or estimated tax under $500). 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: On the rate method, a quarter with no instalment income automatically gives a nil instalment. On the amount method, you can vary based on your revised estimate of tax for the whole year, which can mean a nil instalment for that quarter. If you expect the interruption to last more than one year, talk to the ATO or your tax agent about exiting the system.