The term “tax-free threshold” might sound complicated, but it’s a simple concept that plays a big role in determining how much tax you need to pay. If you have ever started a new job or filled out a tax form, you might have been asked whether you want to claim the tax-free threshold. But what is the tax-free threshold? Understanding what it means can help you make better financial decisions and avoid paying more taxes than you should. Let’s break down the tax-free threshold in simple terms.
What is the tax-free threshold?
The tax-free threshold is the amount of money you can earn before you are required to pay any income tax. In many countries, governments allow individuals to earn a certain amount of income tax-free to help them cover basic living expenses.
In Australia, the tax-free threshold is $18,200 per financial year. This means that if your total income for the year is $18,200 or less, you won’t need to pay any income tax. However, if you earn more than this, you will pay tax only on the amount over $18,200.
How does the tax-free threshold work?
Claiming the tax-free threshold reduces the amount of tax deducted from your salary throughout the year. When you claim the tax-free threshold, your employer calculates your tax based on the assumption that you are entitled to earn $18,200 tax-free. This helps ensure you don’t pay too much tax during the year.
Here’s how it works:
- If your total income is $18,200 or less, you won’t pay any tax.
- If your total income is above $18,200, only the portion exceeding this amount is taxed.
Example:
- If you earn $20,000, you will only pay tax on $1,800 ($20,000 – $18,200).
- If you earn $50,000, you will pay tax on $31,800 ($50,000 – $18,200).
How to claim the tax-free threshold
When you start a new job in Australia, your employer will ask you to complete a Tax File Number (TFN) declaration form. One of the questions on the form is whether you want to claim the tax-free threshold. By claiming it, less tax is deducted from your pay, meaning you’ll have more money in your pocket throughout the year.
Why is the tax-free threshold important?
There are numerous advantages to the tax-free threshold.
- More money for your pocket: In a year’s time, taking the tax-free threshold means deducting less taxes from your checks. This has you with more money and a better supply of cash flows for daily stuff.
- Ease in filing Taxes: A Tax-free Threshold ensures that the correct tax is withheld in the particular year, to minimize the risks of owing for tax when lodging a tax return.
- Support for low-income earners: The tax-free threshold helps low-income earners keep a larger portion of their earnings and, therefore, enjoy a relatively easier living.
When should you not claim the tax-free threshold?
If you do not claim the tax-free threshold, more tax will be withheld from your wages than necessary. While you can claim back any excess tax at the end of the financial year when lodging your tax return, this means you’ll have less money throughout the year.
However, not claiming the tax-free threshold may be necessary in the following cases:
- You have multiple jobs or income sources – you should only claim the tax-free threshold from one employer. If you claim it from multiple employers, you might not have enough tax withheld and could end up with a tax debt.
- You prefer to have extra tax withheld – if you want to avoid the risk of owing tax at the end of the financial year, you may choose not to claim the threshold and have more tax deducted from your pay.
The tax-free threshold and filing a tax return
At the end of each tax year, you need to lodge a tax return with the Australian Taxation Office (ATO). Even if you earn less than $18,200 and don’t pay any tax, you may still need to file a tax return to report your income. If you earn more than the tax-free threshold, your tax return will indicate whether you have paid the right amount of tax. If you have paid too much, you will be refunded. If you have paid too little, you will need to pay the difference.
Tax-free threshold for minors
If you’re under 18, different tax rules apply, particularly for income earned from investments (such as interest or dividends). However, income earned from working, such as a part-time job, is taxed at standard rates, and minors can still claim the tax-free threshold.
Conclusion
The tax-free threshold is one of the key components of the tax system, through which Australians are allowed to earn a certain amount of income without paying any tax on it. By claiming the tax-free threshold, you can decrease the amount of tax withheld from your paychecks and keep more of your earnings throughout the year.
For most people, claiming the tax-free threshold is straightforward. However, if you have multiple income sources, you need to manage it carefully to avoid underpaying or overpaying tax. Whether you’re starting your first job or already working, understanding the tax-free threshold can help you make smarter financial decisions and avoid unnecessary tax liabilities.
