Tax 101: What Is It And How Does It Work?
Some things in life aren’t fun and you may think tax is one of them (most people would agree with you). You might think it’s fine. That you don’t have to deal with it, you’ll just get an accountant to take care of it for you. And you definitely can, that’s why we’re here! But it’s still important for every adult to know the basics of what it is and how it works.
It plays a big part in your life and if you don’t know the fundamentals you may struggle with the concept, especially if you weren’t taught about in properly in school.
We are here to give you a lesson on tax 101, so you don’t have to keep asking your parents for help.
What is Tax?
Workers and businesses pay tax to all levels of Australian government to help fund community needs. If you’re required to pay it, the government will deduct it from your income.
What are some different types of tax?
There are so many types of tax, so here are just a few of the key types you might come across in your working life:
Income tax is the tax paid by individuals who earn an income over a certain threshold. If you have a casual or part-time job during school or uni, you might not earn enough in a year to qualify for income tax yet.
GST is the goods and services tax and is automatically applied in Australia on all purchases.
If you make money through means other than employment or income such as an investment property, you endure a Capital Gains tax on that money. The ATO treats this as normal income earned through employment and therefore it is calculated the same as income tax.
Companies must pay company tax, an income tax on their business profits.
Fringe Benefits Tax (FBT) is an additional tax that businesses need to pay if they provide extra things for their employees (like a company car for example). You can find more information on FBT here.
Who pays tax?
Both individuals and businesses pay tax, but the amount of tax you pay is determined by your income, profits, claimable deductions/offsets, spending and whether you have a tax file number (TFN). As your wage increases, so does the amount of tax you have to pay.
However, not everyone has to pay income tax. These groups include:
- People who earn less than $18,200 per year (they are part of the tax-free threshold).
- People who receive some pensions.
- Some religious, charity and educational organisations.
If you’re employed, your employer will automatically take tax out of your wage and send it to the Australian Taxation Office (ATO). However, if you’re self-employed, you need to do this yourself.
The ATO have provided a table to show how much tax an individual or business pays (excluding the Medicare Levy).
You can decrease the amount of income tax you pay if you’re eligible for tax deductions or offsets.
Possible tax deductions include work related expenses, union fees and donations.
Note: You complete your tax deductions before calculating tax and you won’t receive the full cost back from different claims. Our tip as accountants is to never buy anything only for the tax deduction – you’re still spending unnecessary money unless it’s something you truly need.
If you’re studying part time and working full time in your field of study, you can claim deductions such as:
- Course/tuition fees.
- Stationery and textbooks.
- Student, amenity, and union fees.
Tax offsets reduce the amount of tax an individual pays. The individuals that can apply for tax offsets include individuals who earn a low-middle income and pensioners.
Note: These are applied after calculating tax.
Why do we pay tax?
Australians pay tax to the government to fund community needs such as education, health, defence, and infrastructure. Without tax revenue, the government would not be able to fund and provide these services to the public. Some members of the community are unable to work and therefore it also goes towards funding their pensions and allowances.
All levels of government (Federal, State and Local) collect it; however the Federal Government collects the most.
How does it work when someone starts a job?
Tax becomes most important when you begin working. The amount of work you’re doing and income you’re receiving affects how much tax you must pay, or if you have to pay any at all.
Before you start your first job, you must get a Tax File Number (TFN). Your TFN is your unique reference number for the ATO. You keep your TFN for your whole life, so it is important to keep it safe and ensure you’re the only one using it.
Note: It is crucial that you give your employer your TFN to avoid paying unnecessary tax.
When you start a new job, you must fill out a tax declaration form with your TFN. This ensures they can work out how much tax they need to take out (if any).
Tax-free threshold:
If you don’t expect to earn more than the tax-free threshold ($18,200) in a year, you can tell your employer to apply it on your declaration form, so they won’t withhold tax. If you don’t claim the threshold but earn less than it, your employer will still tax you. However, you can receive this tax back as a refund when you lodge a tax return at the end of a financial year.
The easiest way to keep track of your income, super and tax is by setting up a myGov account and linking in to the ATO. That way you can receive inbox notifications prompting you to meet your tax deadlines and you can submit your income details. However, your employer may already be submitting these details to the ATO via Single Touch Payroll.
Now that you know tax 101, read our blog here to find out how to file a tax return.
For another great resource for beginners, click here!
This is general advice only and has not been prepared with your individual situation or needs in mind. For personalised advice, we highly recommend that you seek professional guidance from a qualified adviser.
