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Tax on extra pays

What do you think would be the best approach to calculating tax on extra pays?

Lump sum payments such as bonuses and back-pay are known as extra pays. The rules are designed to tax extra pays at an employee’s marginal rate.  Currently, this is calculated looking at pay over the four weeks up to the payment date. This amount is annualised and the amount of the extra pay is added. The relevant graduated flat tax rate is then found. Some employers consider this to be complex, and it is not always accurate, particularly when something unusual happened in that four week period (for example, one of the previous pays may have also contained an extra pay).

This approach could be improved by excluding any previous extra pays made in the four-week period, but then adding all extra pays made in the current tax year. Employers using payroll software will easily be able to make this calculation, but it could be difficult for those employers that use manual systems.

A simple option would be to treat extra pays in the same way as normal pay, but this would often result in too much tax being withheld.

Another option would be to calculate a rate based on average year–to-date earnings. This will be accurate late in the year, but less accurate earlier in the year. Again, this will be simpler for employers using software than for those who are not.

A way to resolve this problem might be to give employers a choice of two methods – a simple method which might suit those who use a manual system, which would be less accurate, and a more complex method which might suit those who use payroll software and would be more accurate.

Questions

1.  What do you think is more important – making the method for calculating tax on extra pays simpler for employers, or making the method for calculating tax on extra pays more accurate, to reduce instances of too much tax being withheld for employees?

2.  How do you think the amount of tax to be deducted from an extra pay should be determined?  Do you think the current method is acceptable, or can you suggest a better alternative?

3.  What do you think about the idea of introducing two options – a simple method or a complex, but more accurate, method – that an employer could use to determine the amount of tax to be withheld from an extra pay?  If you like this idea, what do you think the two calculation methods should be?

Comments

Software training contractor
1. Eh? Make it more accurate. Nobody makes extra pays unless they are making too much money ;-) 2. Wouldn't know. I wish I'd been an employer able to make extra pays before... 3. Well we get depreciation options now, why not have a calc method? What about a rate based on average PREVIOUS YEAR to-date earnings?

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8 months ago
Brian Flowers
Employers have to calculate the applicable ESCT for each employee which stays the same throughout the year. Why not base the Extra pay rate on the ESCT rate. I’m not saying it should be the same rate but it’s a good starting point and requires no complicated grossing up of the previous month’s payments.

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8 months ago
Leonie
I would prefer simpler and less accurate (as the employee will eventually get back the small discrepancy anyway)

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8 months ago
Alex Sherbin
Current system works great. One improvement that could be made on that is a simple online calculator to determine your tax refund / payment from schedular payments, results of the simple calculation could be sent to the Inland Revenue and tax refund or payment processed. It does seem a little unfair having to pay a tax agency to process your tax refund or extra payment as a result of the tax system not handling extra pays too well. Alex

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8 months ago
Maree
I'm for the simpler way of doing things. I hate calculating tax on Holiday Pay when employees leave as well. Although it can differ from individuals circumstances, some people have a break between jobs, meaning that the huge tax calculation made by my payroll program is incorrect. Of course, someone leaving one employer with a few weeks accumulated holidays and starting a new job right away DOES need to pay the large tax bill. I often need to muck about with manual overrides with both Extra Pays and terminating employees.

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8 months ago
Common Sense
There is absolutely nothing wrong with the current system for taxing extra pays. The current system generally gives the right answers on an annualised basis so I consider no change is necessary.

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7 months ago
Megan B
The current calculation on the previous 4 weeks is acceptable. Why should the employer have to make a judgement call on what an employee may earn in the future. The employee may not wish the employer to know about future employment if this is to be considered for a complex calculation.

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6 months ago
Noel Reid
Q1 - accuracy every time! Q2 - Annualised calculations is the answer! Q3 - those using payroll systems shouldn't need a simple method.

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5 months ago
Chris Mar
Greater accuracy should always be the goal of any calculation, but as pointed out, depending on the employees circumstance different approaches result in different outcomes. A tweak to existing the existing 4 week calculation rule excluding any extra pay amounts within that four week period would probably be the most accurate approach. This would be easily enough implemented in payroll software. A simple rule for manual calculations seems acceptable, although the two different approaches would need to be clearly communicated to avoid confusion for employers/employees when checking their pay on extra pay amounts.

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5 months ago
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