How is Pay As You Earn (PAYE) tax calculated and paid?

Okay, no problem. As someone who has lived in New Zealand for quite a while and has stepped into my share of tax pitfalls, I'll break down what PAYE is all about for you. Hopefully, this will help you get a complete grasp of it.

How is Personal Income Tax (PAYE) Calculated and Paid?

Simply put, PAYE (Pay As You Earn) is a "pay as you earn" system. To save you the headache of facing a large tax bill at the end of the year, the Inland Revenue Department (IRD) requires you (or rather, your employer) to deduct the due tax from your salary each time you get paid, and then remit it to them. This way, your tax obligation is spread throughout the year.

The entire process can be broken down into three main parts: calculation, payment, and year-end reconciliation.

Part One: How is it Calculated? (The Math Part)

The net pay you receive after each pay cycle is derived from your gross pay minus a number of deductions. PAYE is the largest of these. The calculation of PAYE primarily depends on three key elements: your tax code, tax rates, and other deductions.

1. Your Tax Code

This is the first and most crucial step in the calculation! It tells your employer which set of rules to use when calculating your tax.

• What is it? A tax code is a code you choose based on your personal circumstances (e.g., how many jobs you have, whether you have a student loan, etc.).
• How to choose? On your first day of employment, your employer will ask you to fill out an IR330 Tax Code Declaration form. This form will have a flowchart to guide you step-by-step in choosing the correct code.
• Most common tax codes:
  • M - This is the tax code for most people, meaning "this is my main source of income". If you only have one job and no student loan, this is highly likely your choice.
  • ME - If your annual income is between $24,000 and $48,000, and you meet some other conditions, you can choose this tax code, which allows you to receive a little more money weekly (benefiting from something called the Independent Earner Tax Credit).
  • S - If you work two jobs simultaneously, the tax code for your secondary job must start with S, such as S, SH, ST. This is very important! If you use M for your second job, you are very likely to owe money to the IRD at the end of the year.

Pro-tip: If you choose the wrong tax code, you'll either pay too much tax weekly (which will be refunded at year-end) or too little tax (which you'll have to pay back at year-end). So, take a few minutes to fill out the IR330 form carefully when you start a new job.

2. New Zealand's Personal Income Tax Rates

New Zealand's individual income tax operates on a progressive tax rate system, meaning the higher your income, the higher the tax rate applied to the portion exceeding certain thresholds.

You can imagine it as several buckets; your annual income is poured into these buckets sequentially, and each bucket has a different tax rate.

Here are the current tax rate brackets (for the 2023/2024 tax year):

Example: Let's say your annual salary is $80,000.

• It's not calculated by simply multiplying $80,000 x 33%; this is the most common mistake beginners make!
• The correct calculation is layered, like cutting a cake:
  1. The first $14,000 of your income is taxed at 10.5% => $1,470
  2. The portion from $14,001 to $48,000 (totaling $34,000) is taxed at 17.5% => $5,950
  3. The portion from $48,001 to $70,000 (totaling $22,000) is taxed at 30% => $6,600
  4. Finally, the portion from $70,001 to $80,000 (totaling $10,000) is taxed at 33% => $3,300
  5. Your total annual tax is = $1,470 + $5,950 + $6,600 + $3,300 = $17,320

Don't worry! Your employer's payroll system will automatically handle this complex calculation for you. You just need to understand the principle.

3. Other Deductions in PAYE

What's listed as "PAYE" on your payslip is actually a catch-all term that typically includes the following items:

• ACC Levy (Accident Compensation Corporation Levy): This is mandatory and effectively serves as workplace injury and accident insurance for yourself. Regardless of where you get injured (not limited to the workplace), ACC covers your treatment and rehabilitation costs. The current rate is $1.60 per $100 of income (or 1.6%), with an annual cap.
• Student Loan: 🎓 If you have a New Zealand student loan and your annual income exceeds a certain threshold (currently $24,128), 12% of the amount above that threshold will be automatically deducted to repay your loan. Your tax code will also include SL, e.g., M SL or S SL.

Part Two: How is it Paid? (The Payment Process)

This part is actually the most hassle-free for you as an individual because it's almost entirely handled by your employer.

1. Employer Calculates: Before each payroll run, the company's accountant or payroll software automatically calculates how much PAYE you should pay, based on your tax code and salary level.
2. Employer Deducts: This amount is directly deducted from your gross pay.
3. Employer Remits: Your employer will aggregate all PAYE deducted from all employees' salaries and remit it to the Inland Revenue Department (IRD) before the specified deadline (usually before the 20th of the following month).
4. You Receive Payslip: You will receive a payslip that clearly lists:
   • Gross Pay
   • PAYE (deducted tax)
   • ACC Levy (deducted ACC)
   • KiwiSaver (if you're opted in, relevant deductions will be listed)
   • Net Pay (the amount that goes into your bank account)

Always check your payslip to confirm your tax code is correct and the deductions roughly match your expectations.

Part Three: End of Financial Year

New Zealand's financial year runs from April 1st to March 31st of the following year. After the financial year ends, the IRD conducts an "annual reconciliation".

• Auto-assessment: For the vast majority of employees whose only income is their salary, the IRD will automatically perform a reconciliation after the financial year ends (typically from late May to July). They will add up all the tax your employer paid on your behalf throughout the year and compare it to the tax you should have paid based on your total annual income.
• There are only two outcomes:
  1. Tax Refund: 🎉 If you paid more tax than you should have throughout the year (e.g., you were unemployed for a period mid-year, or initially used an incorrect tax code), the IRD will refund the overpaid amount to you. The money will be automatically transferred to your pre-registered bank account.
  2. Tax Bill: 😟 If you paid less tax than you should have throughout the year (most commonly due to using an incorrect tax code for a second job), the IRD will send you a letter or email informing you how much you need to repay and by what deadline.

Strong Recommendation: Make sure to register for a myIR account on the IRD website. Here, you can:

• View your tax information and history at any time.
• Update your personal details and bank account.
• See the results of your year-end assessment (refund or bill) as soon as they are available.

In Summary

You provide your correct tax code to your employer. Your employer's payroll system automatically deducts PAYE (including income tax and ACC, etc.) from each paycheck and remits it to the IRD on your behalf. After the financial year ends, the IRD performs a final reconciliation, and any overpayments are refunded, while underpayments result in a bill.

I hope this explanation is clear enough! In New Zealand, the tax system is actually very automated and user-friendly. As long as you get your tax code right at the beginning, you generally won't have to worry about it later. I wish you a smooth working and living experience in New Zealand!