How Income Tax works

Updated At : Fri, Dec 27, 2024

Income tax has traditionally been a source of stress and confusion for sole traders. But don't worry – we've got you covered. This step-by-step guide will walk you through what income tax is, how it works, and how you can use PayTax.NZ to simplify and master your tax return.

What is Income Tax?

Income tax is a tax on the money you earn, including profits from your business as a sole trader. In New Zealand, income tax applies to personal income, including self-employment, wages, salaries, benefits, and pensions.

New Zealand uses a progressive tax system, meaning the tax rate increases as your profit increases. These increments are known as 'tax brackets'.

The income tax brackets for New Zealand are:

1. 10.5% – Profit up to $15,600

2. 17.5% – Profit over $15,601 and up to $53,500

3. 30% – Profit over $53,501 and up to $78,100

4. 33% – Profit over $78,101 and up to $180,000

5. 39% – Profit over $180,001

Note: PayTax.NZ automatically applies the correct tax brackets for each financial year.

Do I Need to Register for Income Tax?

No, you don't need to register for income tax or as a sole trader. Just start earning self-employed income, and at the end of your first tax year, file an income tax return.

To file an income tax return you will need a personal IRD number, which you will already have if you've ever working in New Zealand, and a myIR account.

If you don't have an IRD number you can apply for one online. You can also register for myIR online.

How do I calculate income tax in PayTax.NZ?

There are no settings you need to enable for income tax. PayTax.NZ will automatically calculate income tax on your income and expenses, remind you when your tax return is due and provide you with all the figures you need to simply copy and paste into your online tax return.

By default, PayTax.NZ will then automatically calculate your income tax and display your income tax period on the PayTax.NZ Dashboard and on the Taxes Overview page.

When a income tax period becomes due (or overdue), go to the Taxes page to complete/close the period.

Note: When 'Provisional tax' periods are being displayed on the PayTax.NZ Dashboard, you might not see your 'Income tax' period. This is because your provisional tax is your income tax and displaying both would be a double-up.

On the Taxes page you will see all your tax periods for the current financial year and any periods that will become due within the next 12 months.

Note: To file a tax return for the previous financial year, simply categorise an income transaction for that year and the income tax period will appear.

How to file and pay an income tax return

When an income tax period becomes due:

1. Go to the Taxes page in the main menu.

2. Click on the View & Pay button for the due period.

Note: The 'View & Pay' button will only be displayed once the period is due. If a period is currently active, but not yet due, you will see a 'Preview' button instead.

Next, follow the instructions that are shown when you click the 'View & Pay' button:

1. File your income tax return

When your tax return becomes due you need to login to your myIR account and file your return using the figures that PayTax.NZ has calculated. This might seem like a lot of steps but really you just need to copy a few figures from PayTax.NZ. Once you've done it the first time it's really simple.

To file your income tax return:

1. Log in to myIR.

2. Click Returns and transactions under 'Income tax' in your summary.

3. Click File return for the due period.

4. Build your return: Select the income types that you earned during the year and click Next. If you earned taxed income such as salary and wages or schedular payments, these will likely be preselect for you. If you earned self-employed income you will need to select that income type (zero-rated supplies is included in self-employed income).

5. BIC code: Your BIC code, which identifies the main type of work you do, will be automatically displayed. If it's not displayed, find your BIC code. Click Next.

6. Secondary forms: Select This return will include IR 10 Financial Statement and click Next.

7. Specific situation: Select No specific situations apply (unless you're filing a part year return) and click Next. You don't need to include attachments.

8. Disclosures: Select You have no disclosure to make and click Next.

9. Income: If you have income with tax deducted, such as salary, wages or schedular payments these should be automatically be displayed in your return (if they are different to the figures displayed in PayTax.NZ this might be due to an income type that PayTax.NZ doesn't support, or PayTax.NZ might not have updated with the latest income figures). Depending on your situation, copy the following figures from PayTax.NZ:

a. If you have self-employed income - Copy the Self-employed net income figure from PayTax.NZ into your return and click Next.

b. If you have schedular payment income - Copy the Expenses figure from PayTax.NZ into your return and click Next.

c. If you have both self-employed and schedular payment income - Follow the same instructions from option a. (your expenses have already been subtracted from the Self-employed net income figure and don't need to be also included for schedular payments).

10. Tax calculation: You will now see a summary of your total taxable income, any tax that has already been paid (Total tax credits) and how much tax you have left to pay (Residual income tax). If you've paid provisional tax during the year, it will be included in the next step. Click Next.

11. Review: Lastly you will see any provisional tax that's been paid and your estimated total of remaining tax to pay. Click Next.

That's the important part done. Next you need to copy some figures from PayTax.NZ into your Financial statements (IR10).

2. Filing your financial statements (IR10)

The IR10 is part of your tax return and used by the IRD to collect statistics. It might seem a little overwhelming, but that because it's focused at companies rather than sole traders. The figures you enter in the IR10 will not affect how much tax you pay.

Financial statement: Copy the figures from PayTax.NZ info the relevant box in the online return. Click Next.
Balance sheet: If you have depreciated assets in PayTax.NZ you will have figures to copy into the fixed asset fields. Otherwise leave all the fields empty as these are not required for sole traders. Click Next.
Other information: It is unlikely that any of these fields will relate to you. Click Next.

That's it, you should now be able to review and submit your return. Once you have submitted a return it can be changed later in your myIR.

3. Pay the amount due to the IRD

Use the payment options provided when completing your return to pay the due amount to the IRD. Or visit your online banking and use the 'pay tax' function to make payment.

Note: PayTax.NZ doesn't handle any tax payments to the IRD. Tax payments need to be made outside of PayTax.NZ directly from your bank to the IRD.

How PayTax.NZ calculates income tax

The amount of tax you pay depends on your profit (your income minus your expenses) for the tax year (1 April - 31 March).

In order to calculate your profit and the resulting income tax, PayTax.NZ first needs to know your total income and expense for the year so far.

To work out your total income, PayTax.NZ combines any income transactions that have been categorised, with any taxed income. PayTax.NZ then minuses any expenses that have been categorised.

The basic equation looks like this:

+ Categorised income transactions

+ Taxed Income

- Categorised expense transactions

= Profit (taxable income)

Your income tax is then calculated based on your profit, in relation to the income tax brackets mentioned earlier.

If you have both self-employed income and taxed income, such as salary or wages, your self-employed income is added on top of your taxed income.

For example, if you've earned $10k in self-employed income and $50 from a salary, the $10k is not taxed at the lowest tax bracket of 10.5%. It is considered income between $48,000 to $70,000 and therefore taxed at 30% (However, the taxed $50,000 will not be included in the tax calculation.).