How can I avoid an unexpected tax bill?

The Australian Tax Office (ATO) calculates the appropriate amount to withdraw from you every pay period on the basis of 26 fortnightly pay cycles per year. And if you have a 27th pay period in the year, then that’s simply too much income for the tax man to bear and you’ll likely be whacked with a large tax bill, or receive less of a tax refund, after you submit your tax return.

Being that most Australians can’t afford a $1,000 emergency payment, the extra tax could come as a shock.

Dr Adrian Raftery, aka Mr Taxman, told Savings.com.au the 27th pay period is in effect a tax ‘leap year’.

“It will only happen if your first fortnightly pay next year is on 1 July, so not all businesses are going to have 27 pay periods next (financial) year,” he said.

“Essentially there will be some businesses every year which have 27 pay periods - it should be an occurrence once every 10-11 years (when you factor in 29 February).

“Technically your taxable income will be higher for the extra pay period during the year, and as a result the average rate of tax would be higher - compared to if you just had 26 pays.”

So, if you have 27 pays next financial year, and your employer hasn’t cottoned onto that fact yet, what can you do?

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How to avoid a tax bill in tax leap years

While the differential isn’t that much, it does get more pronounced as you earn more, and thus fall into the higher tax brackets.

Ideally, your employer should make adjustments, but this may not be the case according to Dr Raftery.

“As people usually get a refund each year, they probably won’t notice it other than they will get a slightly smaller refund than usual," he said.

“And funnily enough (they will) probably blame their tax agent, even though it's beyond their control.

“Note that it's not the duty of the employer to pay any shortfall out of their own pocket.”

See also: How to build an emergency fund

Calculating your tax shortfall

Below is a rough idea of how much you could owe thanks to the 27th fortnightly pay period in a financial year:

Source: Dr Adrian Raftery (Mr Taxman). Data doesn’t take into account HECS payments or extra Medicare loading.

Of course, not everyone has a nice even fortnightly payment amount. To spread out the extra tax paid during a tax leap year, you can ask your employer to withhold extra tax every fortnight. Here’s how much you might like to withhold:

This is a guide only, and your employer should be able to work it out for you.

Dr Raftery says most individuals can get away with their employer withholding an extra $10 to $20 a fortnight if they think they will be faced with a tax bill at the end of the financial year.

“I would rather be getting a bit more back at year end, so I recommend that as a good forced form of saving,” he said.

So for the price of a fast food meal or two per fortnight, you could avoid a potentially large tax bill at the end of the financial year and maybe even still get a large refund.

While that $10 to $20 you’re sacrificing each fortnight could alternatively be gaining interest in a high-interest savings account, at the current record low interest rates you wouldn’t be missing out on much.

Savings.com.au’s two cents

It sounds like a pretty niche topic, tax leap years. After all, if you stick with one employer and are paid per fortnight, it’ll only happen once every 10 to 11 years. However, this makes it all the more important as tax leap years are easy to forget about.

Similarly, if you change employers in that time you could face a tax leap year more often. While the extra tax paid because you have 27 pay cycles is hardly earth shattering, you could end up owing a few hundred at tax time next year.

If your next pay falls on 1 July, you or your employer may want to make adjustments so that you’re not potentially stung with a tax bill a year from now - the extra adjustments might not even be noticed.

Of course, you may prefer to receive a little more pay each fortnight in exchange for a bigger tax bill or smaller tax refund at the end of the financial year. That way, you’ll have more money in your pocket over the year.

Don’t forget, if you are issued with a large tax bill after you submit your tax return, the ATO may allow you to set up a payment plan so that you can pay it instalments, which may be easier for you.