If you employ anyone in Australia, you are legally required to withhold tax from their pay and send it to the ATO. This obligation is called Pay As You Go (PAYG) withholding, and it applies from the very first pay run you process for your first employee. Getting it wrong can mean underpaying the ATO (which attracts penalties and interest), overpaying your employees (which creates messy corrections), or in serious cases, personal liability for company directors.
Despite being one of the most fundamental employer obligations in Australia, PAYG withholding is routinely misunderstood by small business owners. This guide explains how it works, how to calculate it, how to report it, and what happens when things go wrong.
PAYG withholding is the system through which employers deduct income tax from payments to employees and certain contractors, then remit those amounts to the ATO. The withheld amounts are a prepayment of the recipient's income tax liability for the year.
The system works on a progressive basis. Higher-income employees have more tax withheld, lower-income employees have less, and employees earning below the tax-free threshold of $18,200 per year may have no tax withheld at all (provided they have claimed the threshold on their Tax File Number Declaration).
When your employee lodges their personal tax return at the end of the financial year, the ATO reconciles the total PAYG amounts withheld against their actual tax liability. If too much was withheld, they receive a refund. If too little was withheld, they owe the difference.
As the employer, you are essentially a collection agent for the ATO. The money you withhold is not your money. It belongs to the ATO, held in trust. This distinction matters significantly when it comes to director penalties, which we cover later.
You must register for PAYG withholding with the ATO if you make payments that require withholding. The most common triggers are employing staff (full-time, part-time, or casual), making payments to contractors who have not provided an ABN (you must withhold 47% of the payment), making payments to contractors under voluntary withholding agreements, and paying directors' fees.
You can register for PAYG withholding through the ATO Business Portal, your registered tax or BAS agent, or at the same time as applying for your ABN.
Registration is free and typically processed within a few days. Once registered, the ATO will assign you a reporting frequency (monthly or quarterly) based on how much you expect to withhold annually.
The ATO publishes tax tables that tell you exactly how much to withhold based on each employee's earnings for the pay period, their tax-free threshold claim, and any adjustments (such as HECS-HELP/STSL, Medicare levy, or tax offsets).
Here is a worked example. You employ a full-time worker on a salary of $80,000 per year, paid fortnightly. The employee has claimed the tax-free threshold and has no HECS-HELP debt.
Fortnightly gross pay is $80,000 divided by 26, which equals $3,076.92. Using the ATO's fortnightly tax table for 2025-26 (which includes the Stage 3 tax cuts now in effect), the withholding amount for this income level is approximately $526 per fortnight.
That means you withhold $526, pay the employee $2,550.92 (before super), and owe the ATO $526. Over 26 fortnights, you will remit approximately $13,676 in PAYG withholding for this single employee.
Now add a second employee earning $55,000 per year (approximately $2,115.38 per fortnight). Withholding for this employee is approximately $290 per fortnight, or $7,540 annually.
Combined, you are withholding roughly $21,216 per year for two employees. That keeps you under the $25,000 small withholder threshold, meaning you can report and pay quarterly. Add a third employee, and you might cross that threshold, bumping you to monthly reporting.
Withholding applies to more types of payments than most employers realise.
Salary and wages are the most obvious. This includes regular pay, overtime, bonuses, commissions, and back pay. All are subject to PAYG withholding based on the applicable tax tables.
Leave payments including annual leave, personal or carer's leave, and long service leave are also subject to withholding, both when taken and when paid out on termination. Termination lump sum payments attract withholding, but at different rates depending on the components (such as genuine redundancy amounts, which have tax-free components).
Directors' fees paid to company directors require withholding. Allowances paid to employees (such as car allowances or travel allowances) are generally subject to withholding, though some are treated differently for reporting purposes under STP Phase 2.
Payments to contractors who have not quoted an ABN require withholding at the top marginal rate of 47% (which includes the Medicare levy). This is the "no ABN withholding" rule. If a contractor provides a valid ABN, you generally do not withhold unless a voluntary agreement is in place.
Payments under labour hire arrangements and payments of annuities or pensions can also trigger PAYG withholding, depending on the circumstances.
PAYG withholding is reported through two parallel systems.
Single Touch Payroll (STP) is the real-time reporting channel. Every time you run a pay cycle, your payroll software sends a report to the ATO detailing each employee's year-to-date earnings, tax withheld, and superannuation. STP Phase 2 (mandatory since 1 January 2022) breaks this down into more granular categories including gross, overtime, bonuses and commissions, directors' fees, and salary sacrifice. You can read more about STP compliance in our dedicated STP guide.
Your BAS or IAS is the periodic reporting and payment form. If you are registered for GST, you report PAYG withholding on your quarterly or monthly BAS using labels W1 (total amounts withheld) and W2 (amount payable). If you are not registered for GST, you report through an IAS instead.
The ATO expects these two reporting channels to align. Your cumulative STP data for a quarter should match the W1 figure on your BAS or IAS. Discrepancies are flagged automatically by ATO systems and are one of the most common triggers for compliance activity.
This is one of the biggest points of confusion in Australian tax. The two obligations share the PAYG acronym but are completely different.
PAYG withholding is tax you deduct from payments to others (primarily employees) and send to the ATO. It is their tax, not yours.
PAYG instalments are prepayments of your own business income tax, based on your prior year tax return. The ATO calculates an instalment amount or rate and you pay it quarterly. PAYG instalments are reported on your BAS (labels T1/T2/T7/T8) or on a separate IAS.
A business can have one obligation, both, or neither. A sole trader with no employees but $200,000 in business income will likely have PAYG instalment obligations but no withholding obligations. A company with employees but operating at a loss may have withholding obligations but no instalment obligations. Most established businesses with employees will have both. You can learn more about PAYG instalments and how to vary them in our PAYG instalments guide.
The ATO categorises withholders based on total annual withholding.
Small withholders withhold $25,000 or less per year. They report and pay quarterly, with the same due dates as quarterly BAS (28 October, 28 February, 28 April, 28 July).
Medium withholders withhold between $25,001 and $1 million per year. They must report and pay monthly, due on the 21st of the following month. If a medium withholder lodges BAS quarterly for GST, they lodge monthly IAS for PAYG withholding in the non-quarter-end months.
Large withholders withhold $1 million or more per year. They must pay within six to eight days of each pay event. The exact timing depends on the day wages are paid.
Here is what those thresholds look like in real payroll terms. $25,000 in annual withholding is roughly equivalent to a total payroll of $100,000 to $130,000, depending on employee pay levels and individual circumstances. A business with two full-time employees on average salaries can easily cross this threshold.
Under-withholding from employees is a compliance risk. If you consistently withhold less than required (for example, using the wrong tax table or not accounting for HECS-HELP), your employees will face unexpected tax bills when they lodge their returns. While the immediate financial liability falls on the employee, the ATO may review your withholding practices and apply penalties for failing to withhold the correct amount.
Over-withholding is less legally risky but damages employee trust. Employees notice when their pay seems lower than expected, and consistent over-withholding means they are effectively giving the government an interest-free loan until they lodge their return.
Failing to remit withheld amounts to the ATO is the most serious breach. Remember, PAYG withholding is not your money. The ATO treats unpaid PAYG withholding extremely seriously. The Failure to Lodge penalty for late IAS or BAS lodgement is $330 per penalty unit (one unit per 28 days overdue, up to five units). But the real sting is the director penalty regime.
Under the director penalty provisions, company directors are personally liable for unpaid PAYG withholding. The ATO can issue a Director Penalty Notice (DPN) making the director responsible for the debt from their personal assets. In 2024-25, the ATO issued over 84,000 DPNs, up 136% on the prior year. If the relevant BAS or IAS was lodged on time (even if unpaid), the director can discharge the penalty by placing the company into administration or liquidation. But if the BAS or IAS was not lodged within three months of the due date, the DPN becomes a "lockdown" notice, and the only option is to pay in full. This makes timely lodgement critically important, even when cash is tight. For the full breakdown of director exposure, see our article on director penalties in Australia.
Every Australian tax resident can claim the tax-free threshold of $18,200 per year on one job. This means no tax is withheld on the first $18,200 of annual earnings, which works out to approximately $350 per week, $700 per fortnight, or $1,517 per month.
An employee claims the tax-free threshold by ticking the relevant box on their Tax File Number (TFN) Declaration when they start employment. If an employee has multiple jobs, they should only claim the threshold with one employer (usually the one where they earn the most). Second-job earnings are withheld at higher rates because no tax-free threshold applies.
If an employee does not provide a TFN within 28 days of starting, you must withhold at the top rate of 47% from every payment until a valid TFN is provided.
Employees with study and training support loans (which include HECS-HELP, VET Student Loans, and other government study loans) have additional withholding obligations. From 2025-26, the minimum repayment threshold is $67,000 in repayment income. Above this threshold, repayments are calculated at marginal rates starting at 15 cents per dollar.
As an employer, you must withhold STSL amounts on top of regular PAYG withholding if the employee has indicated a study loan debt on their TFN Declaration. The withholding is reported separately under STP Phase 2. For the full details on STSL withholding rates and thresholds for the current year, see our STSL employer guide.
Use payroll software that automatically applies the correct ATO tax tables. Xero, MYOB, and similar platforms update tax tables automatically at the start of each financial year, but it is worth verifying the update has applied correctly, especially for employees near threshold boundaries.
Ensure every employee has a valid, current TFN Declaration on file. Review these when circumstances change (employee gets a second job, pays off their HECS debt, or changes residency status).
Reconcile your PAYG withholding against STP data before lodging each BAS or IAS. The W1 figure on your BAS should exactly match the sum of all withholding reported through STP for the period.
If you are approaching the $25,000 annual withholding threshold, plan for the transition to monthly reporting. This typically happens when you hire your third or fourth employee.
Set aside withheld amounts in a separate bank account or at minimum track the liability in your accounting software. PAYG withholding is not revenue. Treating it as available cash is one of the most common ways small businesses fall behind on ATO obligations.
Scale Suite's embedded finance team manages end-to-end payroll including PAYG withholding calculations, STP reporting, BAS/IAS preparation, and ATO lodgement. As a registered BAS agent, we take responsibility for accurate, on-time reporting, removing the compliance burden from business owners. If you are spending hours each pay cycle manually checking withholding amounts or worrying about ATO deadlines, we can help.
What is the PAYG withholding rate for 2025-26?T
here is no single rate. PAYG withholding is calculated using the ATO's progressive tax tables based on each employee's earnings, pay frequency, threshold claims, and loan obligations. For the 2025-26 year, the tax brackets are: nil on income up to $18,200, 16% from $18,201 to $45,000, 30% from $45,001 to $135,000, 37% from $135,001 to $190,000, and 45% above $190,000 (plus Medicare levy of 2%). Check our tax tables guide for period-specific withholding amounts.
Do I need to withhold PAYG from contractor payments?
Only if the contractor has not provided an ABN (withhold 47%), if there is a voluntary withholding agreement in place, or if the worker is actually an employee under the ATO's definition (regardless of what the contract says). Misclassifying employees as contractors is a significant compliance risk. See our contractor vs employee classification guide for more detail.
What happens if an employee does not provide a TFN?
You must withhold at the top rate of 47% from every payment until a valid TFN is provided. Give the employee 28 days from their start date to provide it. After 28 days without a TFN, the 47% withholding rate becomes mandatory.
Can I adjust PAYG withholding if an employee asks me to?
Employees can request a withholding variation from the ATO if they have significant deductions or offsets that reduce their tax liability. The ATO will issue a variation notice specifying a reduced withholding rate. You can only adjust withholding based on a valid ATO variation notice, not based on an employee's verbal request.
Is PAYG withholding the same as payroll tax?
No. PAYG withholding is a federal obligation where you withhold income tax from employee wages and remit it to the ATO. Payroll tax is a state or territory tax levied on employers whose total wages exceed a threshold (for example, $1.2 million annually in NSW at 5.45%). They are completely separate obligations with different reporting requirements and different government recipients. See our payroll tax guide for state-by-state thresholds and rates.
Do I still need to lodge if I had no employees in a period?
If you are registered for PAYG withholding and had no withholding activity in a period, you should still lodge a nil BAS or IAS for that period. Failing to lodge, even when the amount is nil, can attract FTL penalties and flag your account for ATO follow-up.
Disclaimer: We review and check articles periodically. At the time of writing, this information was up to date from our assessment. Tax rates, thresholds, and reporting requirements change regularly. Always verify current requirements with the ATO or a registered tax professional for advice specific to your circumstances.
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