PAYG withholding and PAYG instalments share a name but they are not the same obligation. One is tax you collect from other people and pass to the Australian Taxation Office (ATO), the other is your own income tax paid early. This guide explains which one applies to you, which BAS labels each one uses, and the mistakes that catch sole traders out.
Rates last reviewed: October 2026. Figures in this guide are verified against the ATO, linked inline where they matter.
What is the difference between PAYG withholding and PAYG instalments?
PAYG withholding is other people’s tax that you collect and send to the ATO, while PAYG instalments are prepayments toward your own income tax on business or investment income. Withholding starts when you pay employees or certain suppliers, instalments start when the ATO enters you into the system. Both are reported on your activity statement, but at different labels.
“Pay As You Go” describes the timing idea behind both systems: tax is collected across the year instead of landing as one large bill at the end. Everything else differs: whose tax it is, what triggers it, how it is calculated, and which labels it sits at on your Business Activity Statement (BAS) or Instalment Activity Statement (IAS).
If you are a sole trader with no staff, you almost certainly do not have withholding, but you probably will have instalments once your income passes the ATO thresholds. Hire staff and you will have both.
When does PAYG withholding apply to you?
PAYG withholding applies when you pay employees, company directors, or a supplier who has not quoted an Australian Business Number (ABN). You must register for PAYG withholding before the first payment subject to withholding, and you report the amounts on your BAS or IAS.
For employees, you withhold tax from each pay run using the ATO tax tables, based on the tax file number (TFN) declaration the employee gives you. You also report each pay event through Single Touch Payroll (STP). STP does not replace your BAS reporting: you still complete the withholding labels on your activity statement for each period.
Two situations catch small businesses by surprise. If a resident employee does not give you a TFN, you must withhold at 47 percent until a valid TFN is supplied. And if a supplier does not quote an ABN, you must generally withhold 47 percent of the payment.
Watch out: the no-ABN 47 percent rule has exceptions, but you need evidence for them. No withholding is generally required if the payment is 75 dollars or less excluding GST, or if the supplier gives you a completed Statement by a Supplier for a private or hobby supply. If no exception applies, withhold the 47 percent, pay the supplier the balance, and send the withheld amount to the ATO.
How do PAYG instalments work?
PAYG instalments are regular prepayments toward your own expected income tax, credited against your tax when you lodge. You enter the system automatically once your instalment income, tax payable and estimated notional tax all pass the ATO thresholds, and most people then pay quarterly.
The ATO enters individuals, including sole traders, and trusts automatically when all three of these conditions are met on the latest tax return: instalment income of 4,000 dollars or more, tax payable on the latest notice of assessment of 1,000 dollars or more, and estimated (notional) tax of 500 dollars or more. Instalment income is gross business and investment income, not profit, and it excludes GST and capital gains. For a freelancer, invoiced work before expenses counts toward the threshold, which is why many sole traders enter the system sooner than they expect.
You do not apply for instalments in the normal case. The ATO notifies you and sends an activity statement or instalment notice. You can also enter voluntarily through myGov or ATO online services, worth considering in your first profitable year, when your first tax bill and first instalment can otherwise land close together.
Each instalment notice gives you two calculation options: pay the fixed amount the ATO worked out from your last return, or use the instalment rate method, where you multiply your instalment income for the period by the rate the ATO gives you. The rate method rises and falls with your income, so it suits uneven freelance income better.
You can also vary an instalment amount if your circumstances have changed, for example if your income has dropped sharply. Vary with care: if your varied instalments end up below 85 percent of the tax that would have been payable, the ATO can charge general interest charge (GIC) on the shortfall. If your situation changes permanently, you can ask the ATO to exit the system, for example if your instalment income falls below 4,000 dollars or your notional tax falls below 500 dollars.
Which BAS labels do you use for each?
This is where the two systems sit side by side on the same form, and where mixing them up causes the most confusion. The withholding section uses the W labels and the instalment section uses the T labels. Keep them apart and the form mostly fills itself.
| Label | What it means | Which system |
|---|---|---|
| W1 | Total salary, wages and other payments subject to withholding in the period | Withholding |
| W2 | Tax withheld from the payments at W1 | Withholding |
| W4 | Amounts withheld because a supplier did not quote an ABN | Withholding |
| W5 | Total amount withheld (W2 plus other withholding amounts) | Withholding |
| T labels | Your PAYG instalment: income, rate or fixed amount, depending on the option you use | Instalments |
W1 is the gross amount, not the net pay that lands in your employees’ bank accounts, and it does not include compulsory superannuation contributions. W2 is the tax you took out of those payments. A no-ABN amount sits at W4 and flows into the W5 total. Your own instalment sits in the T section of the same statement.
Which form you get depends on your registrations. GST-registered businesses generally lodge a BAS, with GST, withholding and instalment sections all on it. Others with withholding or instalment obligations generally lodge an IAS instead, the same form without the GST section.
Can you have both PAYG withholding and instalments?
Yes, you can have both at the same time, and many established small businesses do. You have withholding when you pay employees or no-ABN suppliers, and you have instalments when your own business income passes the ATO thresholds, so hiring your first employee does not replace your instalments and entering the instalment system does not create a withholding obligation.
Worked example: one quarter with both systems
Maya is a sole trader graphic designer in Melbourne. She is GST registered, she has one part-time assistant, and the ATO has entered her into the PAYG instalment system. The numbers below are for the PAYG sections of her September quarter BAS only.
During the quarter, Maya pays her assistant gross wages of 12,000 dollars and withholds 2,100 dollars of tax from those wages. She also pays a contractor 2,000 dollars for overflow design work, but the contractor does not quote an ABN and no exception applies, so Maya must withhold 47 percent of that payment.
Step 1, withholding labels. W1 is the gross wages: 12,000 dollars. W2 is the tax withheld from those wages: 2,100 dollars. The no-ABN withholding is 47 percent of 2,000 dollars, which is 940 dollars, reported at W4. W5, the total withheld, is 2,100 dollars plus 940 dollars, which is 3,040 dollars.
Step 2, her own instalment. The ATO set Maya’s quarterly instalment amount at 1,850 dollars, which she reports at the T labels.
Step 3, the PAYG total for the quarter. The withholding total of 3,040 dollars plus her instalment of 1,850 dollars gives 4,890 dollars for the PAYG sections, before the GST section is added. That single payment covers two different people’s tax: 3,040 dollars of it is other people’s tax she collected, and 1,850 dollars is her own tax paid early.
At tax time the picture reconciles. Suppose Maya’s final tax for the year is 9,400 dollars and she paid four quarterly instalments of 1,850 dollars, a total of 7,400 dollars. The instalments are credited against her tax, so she owes the remaining 2,000 dollars when she lodges. The withholding amounts never enter her own tax calculation: they were credited to her assistant and her contractor when they lodge their own returns.
Tip: if Maya’s contractor had quoted an ABN, there would be no W4 amount and her W5 total would be 2,100 dollars. Asking every supplier for their ABN before you pay is the cheapest habit in this guide. Our guide to invoicing as a sole trader in Australia covers what belongs on your own invoices so your clients never have to withhold from you.
A decision framework: which PAYG system applies to you?
Use this framework instead of guessing from the shared name. Work through the rows in order and tick every one that applies, then check the notes below the table for the row most freelancers get wrong. It covers the five situations sole traders actually face.
| Your situation | Withholding? | Instalments? |
|---|---|---|
| Sole trader, no staff, all clients quote ABNs or pay you directly | No | Yes, once you pass the ATO thresholds |
| Sole trader who hires an employee or casual | Yes, from the first pay run | Yes, if your own income passes the thresholds |
| Business paying a supplier who will not quote an ABN | Yes, 47 percent on that payment | Depends on your own income |
| Freelancer whose client withholds from you because you gave no ABN | No, your client is the withholder | Your own instalments still apply |
| Employee with a side business | Your employer withholds your salary tax | Yes, on your business income |
The row most freelancers miss is the fourth one. If a client withholds 47 percent from your invoice because you did not quote an ABN, that withholding is not your instalment system and it does not reduce your instalment amount. It is a credit against your final tax when you lodge. Fix it by quoting your ABN on every invoice.
For planning, our guide to how much tax an Australian sole trader should set aside explains how instalments fit into your tax reserve, and our BAS explainer walks through the full form. Our Australia GST guide covers the 10 percent rate and the 75,000 dollar registration threshold.
Mistakes that cost sole traders money
Paying your own drawings as if they were wages. A sole trader who reports drawings at W1 creates a withholding obligation that does not exist. Drawings are not a payment subject to withholding.
Forgetting the no-ABN check before paying a supplier. The 47 percent rule is easy to miss on a small invoice, and the ATO can still expect the withheld amount even after you have paid the supplier in full. Build the ABN check into your payment routine: no ABN on the invoice means pause and ask for it first.
Treating the instalment amount as a final tax bill. The fixed amount the ATO sends is an estimate from your last return. If your income has grown, it will understate your tax and a balance will fall due at lodgement. If your income has fallen, varying the instalment or using the rate method keeps you from overpaying all year. Review the amount each quarter.
Mixing up the labels on the BAS. W1 is gross wages, not net pay, and W2 is the tax withheld, not the wages themselves. Swapping them overstates your withholding and understates your wage bill. Reconcile W1 and W2 to your payroll summary before you lodge.
Finally, do not confuse either PAYG system with superannuation. If you employ staff, the superannuation guarantee is a separate obligation on top of withholding. LancerBill’s profit margin calculator can help you check that a job still makes sense once staff costs and your own instalments are priced in, and the free invoice generator puts your ABN on every invoice so clients never need to withhold from you. For GST arithmetic on those invoices, use LancerBill’s GST calculator.
Key takeaways
- PAYG withholding is other people’s tax you collect; PAYG instalments are your own tax paid early.
- Withholding is triggered by paying employees, directors or no-ABN suppliers, and is reported at the W labels.
- Instalments start automatically when your instalment income, tax payable and notional tax pass the ATO thresholds, and are reported at the T labels.
- You can have both systems at once; they are calculated separately but paid together on your activity statement.
- Every instalment is credited against your final tax, and quoting your ABN on every invoice avoids 47 percent withholding from your own payments.
- Vary instalments when your income changes, but keep varied amounts above 85 percent of your expected tax to avoid general interest charge.
Do sole traders have PAYG withholding?
Only if they make payments subject to withholding, such as paying an employee or a supplier who has not quoted an ABN. A sole trader with no staff generally has no withholding obligation. Their own tax is handled through PAYG instalments.
What is the difference between PAYG withholding and PAYG instalments in Australia?
Withholding is tax you deduct from payments to employees or certain suppliers and send to the ATO on their behalf, reported at the W labels on your BAS. Instalments are prepayments toward your own income tax, reported at the T labels. One is other people’s tax, the other is your own.
How much do you withhold if a supplier does not quote an ABN?
You generally withhold 47 percent of the payment, the top marginal rate including the Medicare levy, and report it at W4 on your BAS. Exceptions include payments of 75 dollars or less excluding GST and suppliers who give you a completed Statement by a Supplier.
When do you automatically enter the PAYG instalment system?
As an individual or sole trader, the ATO enters you automatically when your latest tax return shows instalment income of 4,000 dollars or more, tax payable of 1,000 dollars or more, and estimated notional tax of 500 dollars or more. All three conditions must be met.
Can you vary or exit PAYG instalments?
Yes. You can vary an instalment amount if your circumstances have changed, but if your varied total ends up below 85 percent of your actual tax, the ATO can charge general interest charge on the shortfall. You can also ask to exit if your instalment income falls below 4,000 dollars or your notional tax falls below 500 dollars.
Do PAYG instalments reduce your final tax bill?
Yes. Every instalment is credited against your tax when you lodge your annual return. If your instalments exceed your final tax, the difference is refunded. If they fall short, you pay the balance.
Sources: ATO, Starting PAYG instalments; ATO PAYG withholding and no-ABN guidance; ATO activity statement labels (W1, W2, W4, W5, T labels).
This guide is for general information only and is not financial, tax or legal advice.