Quick answer: PAYG instalments are the ATO’s way of collecting this year’s tax on your business and investment income in quarterly chunks, instead of one big bill at tax time. You get entered automatically when your last return shows enough business or investment income ($4,000 of instalment income and $1,000 of tax for individuals). They are prepayments, not extra tax — every dollar is credited against your assessment. You can vary them down if this year will be quieter, and you can get out of the system entirely if you stop earning that income. In 2026-27 there are two things worth knowing: the ATO’s default amount is 5% higher than last year (the GDP uplift), and the second-bracket tax cut from 16% to 15% means many people’s ATO-set rates are up to $268 too high.
What PAYG instalments actually are (and what they’re not)
The name causes most of the confusion. PAYG withholding is what your employer does — they withhold tax from your wages and send it to the ATO. PAYG instalments are the self-employed and investor version: you prepay your own expected income tax during the year, in quarterly instalments, on income that doesn’t have tax withheld at the source — business profit, rent, dividends, interest, partnership and trust distributions.
The question every accountant hears on loop — “is this extra tax on top of my normal tax?” — has a one-word answer: no. When you lodge your return, the ATO credits every instalment dollar against your assessment. If you overpaid across the year, you get the excess back. If you underpaid, you owe the balance. The instalments just move when you pay, not how much you pay. The sting is cash-flow, not tax.
Who gets pulled into the system: the entry rules
Most people don’t choose PAYG instalments — the ATO enrols them automatically after processing a tax return. The entry tests for 2026-27:
| Entity | Automatic entry when… |
|---|---|
| Individuals (incl. sole traders), trusts | ALL three hold: instalment income of $4,000+ on the latest return; tax payable of $1,000+ on the latest notice of assessment; estimated (notional) tax of $500+ |
| Companies and super funds | ANY one holds: instalment income of $2 million+; OR estimated notional tax of $500+; OR the company is the head of a consolidated group |
A nasty surprise buried in those rules: capital gains count toward the tax-payable trigger but are excluded from instalment income (except for super funds). Sell some shares at a profit, push your assessment tax over $1,000, and you can land in the PAYG instalment system even though the gain itself won’t be part of what you prepay on. Employees with a side hustle or a rental property are the classic accidental entrants.
The year-2 cash-flow ambush (plan for this)
Here’s the trap that breaks first-year businesses. Say 2025-26 is your first profitable year as a sole trader: $95,000 taxable profit. Tax at 2026-27 rates: 15% on the $26,800 between $18,200 and $45,000 ($4,020), plus 30% on the $50,000 above $45,000 ($15,000) — $19,020, plus $1,900 Medicare levy. $20,920 bill on assessment.
Then the ATO auto-enters you into PAYG instalments for 2026-27. Your quarterly amount = $20,920 ÷ 4 × 1.05 (the GDP uplift) = $5,492 per quarter, about $21,966 for the year. In 2026-27 you pay last year’s $20,920 and this year’s instalments: $42,886 out in a single year. The social-media crowd calls it the “year 2 tax ambush”, and it’s real.
The escape hatch is voluntary entry. If you start prepaying in year one — before the ATO enrols you — the ambush never happens. A freelance designer expecting 2026-27 business income of $55,000 with $8,000 of deductions has $47,000 taxable: $4,620 tax plus $940 Medicare = $5,560, or $1,390 a quarter voluntarily. Registration takes minutes via myGov: Tax → Manage → Tax Registrations → Add new registration → PAYG instalments (or through your agent, or by calling 13 28 61). If your first profitable year is coming, register before it arrives.
Rate vs amount: the two ways you can pay
Your activity statement or instalment notice offers two payment methods. You can switch between them.
| Amount method | Rate method | |
|---|---|---|
| How it’s set | ATO calculates a fixed quarterly amount from your last return’s notional tax, plus the 5% GDP uplift for 2026-27 | ATO sets a percentage rate: (estimated notional tax ÷ instalment income) × 100 |
| You pay | The same dollar figure every quarter | The rate × this quarter’s actual instalment income |
| Best for | Steady, predictable income | Seasonal or lumpy income |
Why the rate method wins for uneven income — worked: a tradie with notional tax of $25,720. On the amount method he pays $25,720 ÷ 4 × 1.05 = $6,752 every quarter, including the dead winter quarter. On the rate method (23.38%), a $10,000 quarter costs $2,338 and a $45,000 quarter costs $10,521. Roughly the same annual total — but the payments follow the work. And note the uplift math: that 5% adds $1,286 a year to the amount-method payer versus last year’s tax, for nothing changing. If your income is steady, check whether your 2026-27 figure is simply last year’s tax plus 5%.
One more 2026-27 quirk that makes the rate method attractive this year: the ATO set your rate or amount off your 2025-26 return, taxed at 16% in the second bracket. From 1 July 2026 that bracket is 15%. For anyone earning at least $45,000, the cut is worth 1% of the full $26,800 band — up to $268 — which means many people’s ATO-set instalments are up to $268 a year too high. That’s a legitimate, timely reason to consider a variation (below).
How to vary your instalments (the how-to that matters)
You don’t need permission to vary — you do it on the activity statement or instalment notice itself, on or before the due date. The varied figure applies to the remaining instalments for the year, unless you vary again. You can vary down, vary up, or vary to zero.
Varying the amount — fill in T8 (your estimated tax for the year), T9 (your varied amount for the quarter — enter 0 if nil), T4 (a reason code), and 5A carries the payable figure. If your varied amount is negative, claim the credit for earlier overpaid quarters at 5B.
Varying the rate — fill in T1 (instalment income for the period), T3 (your varied rate — 0 if nil), T11 (T1 × T3), T4 (reason code), and 5A carries the payable. You only need to vary on the rate method if the taxable proportion of your income has changed — income going up and down is already handled, because the rate multiplies this quarter’s actual income.
Worked — varying a rate down: Maya, sole trader. 2025-26: $120,000 instalment income, notional tax $28,920 including Medicare. The ATO’s rate = $28,920 ÷ $120,000 × 100 = 24.10%. But 2026-27 is slower: expected instalment income $80,000 → estimated tax = $4,020 + ($80,000 − $45,000) × 30% = $14,520, plus $1,600 Medicare = $16,120. Her varied rate = $16,120 ÷ $80,000 × 100 = 20.15%. On a $18,000 quarter, the ATO rate charges $4,338; the varied rate charges $3,627 — $711 of quarterly cash-flow back in her pocket, entered at T3 with reason code 23 (significant change in trading conditions).
Reason codes the ATO expects at T4 include 21 (change in investments), 22 (business ceased), 23 (significant change in trading conditions), 24 (restructure) and 25 (legislation or product mix). And yes — varying to zero is explicitly allowed: if your estimated instalment income is zero, you can vary the amount or the rate to nil without providing a tax estimate. That said, read the next section before you do it three years running.
⚠️ The nil-variation crackdown (October 2026)
This is fresh and worth knowing: the ATO is currently writing to taxpayers who have varied their instalments to nil over multiple years, asking them to justify it. The letters are a compliance sweep, not random. Varying to $0 when you genuinely expect no instalment income is perfectly legal — the ATO’s own guidance allows it. What draws the letters is repeated nil variations while income keeps appearing on your return, because the gap between your variation and reality looks like deliberate underpayment.
If you get one of these letters: don’t ignore it. Gather your workings — the income forecast, the reason code you used, bank or sales records backing the estimate — and respond by the due date. Keep a one-page note with every variation you make: what you estimated, why, and the numbers behind it. That paper trail is what separates a “genuinely quiet year” from a GIC assessment. Talk to your accountant before varying to nil if the ATO has already queried you once.
The 85% safe harbour — in actual dollars
Every guide quotes the rule and stops. Here it is with money attached: if your varied instalments for the year total at least 85% of your actual tax payable on instalment income, you’re safe — no interest. Fall below 85% and the ATO charges the general interest charge (GIC) on the difference, plus possible penalties. And since 1 July 2025, GIC is no longer tax-deductible — it costs the full rate. For October–December 2026 that rate is 11.51% per annum, compounding daily.
Worked: Maya (above) pays Q1 and Q2 at the ATO rate — $4,820 + $4,820 = $9,640 — then a big contract collapses and she varies Q3/Q4 to $0. Year-end actual tax on her instalment income: $16,120. The 85% benchmark = $13,702. She paid $9,640, which is below the line — so GIC applies to the $4,062 difference at roughly 11.51% compounding daily, about $495 over a year, and it’s not deductible. She also still owes the $6,480 actual shortfall. The lesson: vary to a realistic estimate, not to hope. The ATO’s own advice is blunt: “If you’re not sure, it is best not to vary.”
What counts at T1 — the reporting mistakes that cost money
Instalment income (label T1) is gross business and investment income, excluding GST. The ATO has published the errors it sees taxpayers make again and again:
| T1: include | T1: leave OUT |
|---|---|
| Gross sales, fees and commissions (before expenses) | Salary and wages (tax already withheld) |
| Gross rent received | Capital gains (except super funds) |
| Dividends — cash amount only | Franking credits attached to dividends |
| Interest, royalties | GST you collected |
| Your share of partnership/trust income | Exempt income |
| Fuel tax credits, TFN-withheld amounts | Your expenses and deductions (T1 is gross, not net) |
The big three errors: reporting net income instead of gross (you’d underpay every quarter), adding franking credits to dividends (you’d overpay), and including salary that’s already had withholding taken (double-counting). If your instalments have felt oddly high or low for years, check T1 first — a franking-credit inclusion alone can inflate a dividend investor’s quarterly bill by ~30%.
How to get out: the exit rules
Almost nobody’s guide covers this, and it’s one of the most-asked questions: “how do I get out of PAYG instalments?” The ATO removes you automatically if:
- Your instalment income drops below $4,000 (residents)
- Your tax debt on the latest assessment is under $1,000 (after PAYGI adjustments)
- Your notional tax is under $500
- Your instalment rate is 0.0%
- You become eligible for the seniors and pensioners tax offset (SAPTO)
- You lodge a final return or a non-lodgment advice
You can also request early exit through myGov or your tax agent — useful when the business has closed but the ATO is still working off last year’s return (the single most common “why am I still in this?” complaint). Vary to nil for the current year and request the exit; the variation handles the quarters, the exit stops next year’s notices.
Quick answers to the questions people actually ask
Can I just opt out and pay once a year? Not while you meet the entry tests — it’s compulsory, not optional. But you can vary instalments to reflect a genuinely lower year, and you can request an exit when the income stops. “I only want to pay my tax once a year” isn’t a reason the ATO accepts; “my business closed in September” is.
My business is no longer trading — why did I get an instalment rate? Because the ATO enrolled you off last year’s return. Vary to nil (reason code 22 — business ceased) and request to exit. Don’t just ignore the notice; unlodged instalment notices attract their own penalties.
Do instalments reduce last year’s tax bill? No — a very common mix-up. They prepay this year’s tax. Your assessed bill from last year is separate and still due.
What if I simply don’t pay? The instalment becomes a tax debt: GIC accrues daily at 11.51% p.a. (non-deductible), and the ATO can garnish or offset it against refunds. If cash is the problem, a payment plan beats silence every time.
I’m on the rate method and my income fell — do I need to vary? Usually not. The rate multiplies this quarter’s actual income, so a quieter quarter automatically produces a smaller payment. You’d only vary if the profitability changed — for example, income fell but costs stayed high, so the tax proportion is lower than the rate assumes.
Does the new $1,000 standard deduction affect my instalments? Barely. It applies from 2026-27 for resident individuals with labour income and no receipts needed — but instalment income (T1) is gross, so the deduction doesn’t touch it. It can only shave a little off notional tax for employee-investors. Don’t vary on the back of it.
The bottom line
PAYG instalments are plumbing, not punishment: the ATO collects this year’s tax as you earn it instead of surprising you with one bill. For 2026-27, three things deserve your attention. First, check whether your ATO-set figure is just last year’s tax plus the 5% uplift — and whether the 16%-to-15% bracket cut has left it up to $268 too high. Second, if your income is seasonal, the rate method follows your cash flow while the amount method doesn’t. Third, vary with workings, keep the one-page note, and stay above the 85% line — the GIC is 11.51%, daily, and no longer deductible. Use the income tax calculator to model your expected 2026-27 liability before you touch a variation, and run anything borderline past your accountant first — that’s the ATO’s advice too. Related reading: income tax rates 2026-27, the tax deductions checklist, side hustle tax, and sole trader vs company tax.
Sources: ATO — PAYG instalments: how to complete your activity statement; ATO guidance on varying instalments, entry thresholds and the 85% rule; ATO GIC rates. Figures verified against live ATO pages on 15 October 2026.
