PAYG Instalments for Sole Traders, Explained (2025–26)
Why the ATO put you on PAYG instalments, what they actually are (not an extra tax), and how to vary them if your income drops — a plain-English guide for sole traders.
If the ATO has just told you you are now paying “PAYG instalments”, do not panic — and importantly, it is not a new or extra tax. It is one of the most misunderstood letters a sole trader gets. Here is what is actually going on and what to do about it.
Why this happened
As an employee, tax comes out of each payslip before you are paid. As a sole trader, no one withholds anything — so without instalments you would face one big tax bill once a year. PAYG instalments spread that bill across the year, in quarterly prepayments, so you are not hit with a lump sum at lodgment. The ATO automatically enters you once your most recent return shows business and investment income, and a tax bill, above its thresholds. You did not do anything wrong — it is a sign you are earning.
The key thing to understand
Every dollar you pay in instalments is credited against your final tax bill for the year. It is a prepayment, not a surcharge. At tax time, your instalments are added up and subtracted from what you owe — pay too much across the year and you are refunded the difference; too little and you top up. So the money is not lost and it is not extra; it is just paid earlier, in smaller pieces.
How you pay
Each quarter the ATO gives you two ways to work out the instalment:
- Option 1 — the instalment amount: the ATO pre-fills a dollar figure based on your last return. Simplest; just pay it.
- Option 2 — the instalment rate: you multiply a rate the ATO gives you by your actual income for that quarter. Better if your income is lumpy or seasonal, because you pay in proportion to what you actually earned.
Most sole traders pay quarterly; some are eligible to pay annually.
How to vary them (and the trap)
If your income has genuinely dropped — a slow year, you have wound back, you have stopped trading — you can vary your instalment down so you are not prepaying tax on income you will not earn. You do it on the activity statement before the due date.
The trap: if you vary too far down — broadly, if your varied instalments end up more than 15% short of what you actually owed — the ATO can charge interest (the general interest charge) on the shortfall. So vary to a realistic figure, not an optimistic one. If in doubt, the safer move is to pay the ATO’s amount and get the overpayment back as a refund.
The watch-outs
- Do not ignore the letter: unpaid instalments attract interest, and missing them does not make the tax go away.
- It is not extra tax: resist the instinct to treat it as a new cost; it is your existing tax, paid in advance.
- Vary on genuine change, not hope: over-varying is where the penalties live.
- Set the money aside: park a percentage of every payment received so each quarter’s instalment is already covered.
Bottom line
PAYG instalments are the ATO smoothing your annual tax bill into quarterly prepayments now that you are earning as a sole trader. They are credited against your final bill, so they are not extra — just earlier. Pay the ATO’s amount if your income is steady, switch to the rate option if it is lumpy, and only vary down when your income has genuinely fallen (and not by more than reality supports).
Frequently Asked Questions
Is a PAYG instalment an extra tax?
No. It is a prepayment of your normal income tax, credited against your final bill at tax time. It is the same tax, paid earlier in quarterly pieces rather than as one lump sum.
Why was I put on PAYG instalments?
The ATO enters you automatically once your most recent return shows business or investment income and a tax bill above its thresholds. It is triggered by your last return, not by anything you did wrong.
Can I reduce my PAYG instalments?
Yes, you can vary them down if your income has genuinely dropped. But if you under-pay by more than about 15% of the actual amount, the ATO can charge interest on the shortfall, so vary to a realistic figure.
Are PAYG instalments quarterly or annual?
Most sole traders pay quarterly. Some are eligible to pay annually. The ATO tells you which applies and pre-fills the amount or rate each period.