Talking Tax Rates, Bills and Refunds

Many people can receive a surprise at the end of the financial year: either a pleasant surprise in the form of a tax refund, or a rather unpleasant one if a tax bill arrives.

New Zealand’s taxation system is generally poorly understood, and we often hear misleading or inaccurate statements about income and tax brackets. Fundamentally, it gets thrown into the "too hard basket!" At PaySauce, we want to take the hassle out of getting tax-educated and give everything you need to know about tax rates, bills and refunds in just one blog.

To understand why we sometimes receive bills or refunds, we’ll cover off a very basic explanation of how employment earnings are taxed and then list some common reasons for bills or refunds.

How does PAYE work?

PAYE stands for Pay As You Earn. IRD sets out very specific guidelines for calculating tax from salary or wages which payroll systems must follow. This is according to Payroll Calculations & Business Rules as laid out by IRD.

Very roughly, for M (or Main Income) tax codes it looks like this:

1. Take the total gross taxable amount for the pay period
2. Multiply it by the appropriate number for the pay frequency (52 for weekly, 26 for fortnightly or 12 for monthly)
3. Take this total amount which is the "annualised" earnings and work out the applicable tax as if that was the earnings for the year
4. Divide that tax amount by 52 to get a weekly value
5. If relevant, multiply back again to the appropriate frequency (fortnightly or monthly)

This gives you the amount of PAYE that will be deducted in that pay period. Also included is the relevant percentage for the ACC Earner Levy, an amount that individuals pay towards ACC each year. The steps are important, as IRD gives specific instructions for either rounding or truncating to cents or whole dollars in some places.

This process is repeated for each pay period.

This "annualisation" of the earnings every pay period means that every pay period is sort of "self-contained." The tax calculations for the pay period are only based on the earnings in the current period in isolation, and the PAYE system doesn’t have a way of recognising that earnings may have been different or may change throughout the year, or accounting for what has already been paid. The value is simply calculated using the earnings for the current period.

There are different rates of tax which are applied to ranges of earnings, however this is always calculated based on the total amount you’re earning in the current period as if you would receive that for a year.

Is everything taxed like that?

No, that would be far too simple! Sometimes, "flat" rates are used. That means the value simply has the appropriate tax rate applied to the whole amount.

To keep things super simple, we’ll just talk briefly about this. There are two main cases where this would apply:

1. Other tax codes that are not M codes (M, M SL, ME, ME SL)
2. Extra pays/lump sums

Other tax codes

Secondary tax codes use "flat" rates. The flat rate that is used is different for each of the secondary codes. The correct secondary code has to be chosen by the earner to ensure the secondary earnings are being correctly taxed based on the total expected earnings for the year. You can read more about those here: Tax codes and rates for individuals

Other special tax codes can use flat rates too, such as CAE and EDW. These are only used in specific circumstances so we won’t talk about them in detail here, you can read more information on the IRD website.

Extra pays

Extra pays, also known as lump sums, are a special type of payment that IRD sets out different taxation rules for. They are used for specific types of payments. You can read more about them here: Lump sum payments.

Payments like annual leave cash ups, termination pays, back pay and bonuses should be taxed using lump sum rates.

The way a lump sum tax rate is chosen is dependent on what the employee has earned in the four weeks prior to the lump sum payment. Here’s a very basic view of how these tax rates are calculated:

1. Take the total value of PAYE earnings (i.e. excluding any other extra pay payments or non taxable amounts) in the last four weeks prior to the period in which you are paying the lump sum
2. Multiply the value by the appropriate amount to arrive at "annualised income"
   1. If you pay weekly, the last four weeks multiplied by 13
   2. If you pay fortnightly, the last two fortnightly pays multiplied by 13
   3. If you pay monthly, the last month multiplied by 12
3. Take this "annualised income" and add the value of of the extra payment
4. Use this final amount to determine the appropriate tax rate (i.e. if the final result was $74,500, you would choose the tax rate for $70,001 - $180,000)
5. Apply that tax rate to the value of the extra pay.

We have simplified this a lot, because there are some other things to consider - but it's important to understand that extra pays (lump sums) have a different way of being taxed, and that rate is decided based on the last four weeks of earnings prior to the payment being made.

Employees can, of course, ask for a higher tax rate to be applied than the one automatically selected by this process. They cannot choose a lower one.

So, why the bill?

There are many reasons why someone might receive a bill or refund. It is important to know that payroll software providers must comply with the specific taxation calculations that IRD provides, and complying with those rules may from time to time mean that someone’s income and tax at the end of the year results in a small under or over payment.

The nature of the PAYE system that looks solely at each pay period which can result in differences if someone’s pay varies throughout the year, and lump sum rates can cause ups or downs in the end result too.

That said, we’ve seen lots of this over our years in payroll, so here are of the ways we’ve seen bills or refunds arise:

• It may be that the lump sum rate which was correctly calculated at the time (based on the last four weeks earnings) didn’t match what the employee ultimately ended up earning for the year
• Depending on pay days, there may have been 53 weekly pays or 27 fortnightly pays. The PAYE system doesn’t really allow for this, because all calculations are based on multiplying/dividing by 52 or 26 for weekly and fortnightly
• The employee may have had a period of other earnings which they did not realise meant they needed to use a secondary tax code for (i.e. being paid for keeping in touch hours while on parental leave, or receiving top ups from an employer while on ACC). When income is being received from two sources, one must be taxed at secondary rates. Employees must select their own tax rate by completing an IR330
• They may have been using the incorrect tax code for a period of time, for instance using ME when they did not qualify or using the incorrect secondary tax code
• They may have earnings from other sources not related to employment which are being accounted for when IRD assesses all of their income, such as using the incorrect PIR (prescribed investor rate) on investments/KiwiSaver

In particular, in 2024, if you paid before Easter to avoid the public holidays you may have 53 weekly pays or 27 fortnightly pays in your financial year.

What are the employer's obligations?

Employers have many obligations towards their employees and relating to tax. You must calculate, deduct and file PAYE and other tax according to the rules set out by IRD. This includes requiring employees to complete a tax code declaration (IR330) so that you can tax them at the rate they have specified to you, or changing the rate if IRD advises you to.

You are required to calculate and deduct tax following the specifications IRD has set out - this is easy if you’re using PaySauce, of course!

Your responsibility as an employer is to deduct, file and pay in accordance with those specifications from IRD. You may want to assist your employees in trying to find out why they have been issued a bill, but it is important to understand that:

1. personal specific circumstances for the employee may be impacting the result, and
2. variances, including under or overpayment, can appear even when following the rules exactly. They’re not perfect and they don’t account exactly for several things such as additional pay periods or variations throughout the year.

Trying to understand why an employee has received a bill can sometimes be quite straightforward, for example when there is an additional pay period and the amount seems to match this well. However, sometimes it requires additional knowledge about someone’s other earnings or circumstances which an employer simply won’t know.

Employees will ultimately need to discuss their bill or refund with IRD or an accountant to understand it. Employers must provide records to an employee to support them in understanding their payments and tax that has been deducted.

IRD may allow write-offs in specific circumstances. Their threshold for automatic write offs is $50. This was increased to $200 as part of pandemic support post COVID-19, but is back at $50. Write-off may be approved where a bill relates solely to an additional pay period in a financial year, which you can read more about here: Income tax assessments and write-offs.

Conclusion

In short, there are many reasons why an employee may have received a tax bill or refund after their end of year assessment from IRD. Varying factors need to be considered, and payroll might not always be the answer - though sometimes it is, for reasons relating to the way our tax system works in New Zealand.

Employers need to make sure they are using a payroll system that adheres to the IRD specifications, and then use that payroll system in the appropriate way for the payment type. If you need reassurance, you can ask your payroll provider for information on a specific outcome or result you’re looking at to ensure it complies with the IRD specifications.

Employees need to be aware of their obligations about correctly stating a tax code, including selecting a (correct) secondary tax code when their situation requires it. Employees also need to be aware that the tax system in New Zealand isn’t necessarily perfect and even with everything done right, there can still be over or underpayments in tax once everything is washed up at the end of the year. Being aware of the write off rules can be useful, but be aware they only apply in limited circumstances.

Finally, if you or someone you know has received a tax bill that they are struggling to pay, you should be aware of how you can discuss this with IRD. Contacting IRD proactively to make an arrangement is the best path forward. Read more on the IRD website here: Unable to pay tax debt.

Disclaimer: The information provided in this post is for general informational and educational purposes only. It is not intended as, and should not be construed as, professional tax or financial advice.