No one enjoys talking about tax—but for self-employed business owners, it’s part of the deal.
Most people know that at the end of the financial year you file a tax return and pay tax based on what you’ve earned. What often comes as a surprise is that, depending on your income, you may also need to pay tax in advance. This is known as provisional tax.
So what is provisional tax, who has to pay it, and how does it work? Let’s break it down.
At the end of each financial year, you calculate your residual tax—the income tax you owe on earnings that haven’t already been taxed. This applies to business and self-employed income, not PAYE wages, which are taxed at source.
If your residual tax bill is more than $5,000, you’ll be required to pay provisional tax for the following financial year.
While paying tax early isn’t anyone’s favourite idea, there is a silver lining: provisional tax usually means your business is doing well. You only pay more tax when you earn more.
You’ll know whether provisional tax applies when you complete your tax return. Once your residual tax is calculated, it becomes clear whether you’ve crossed the $5,000 threshold.
If you earn income from multiple sources—such as a salary plus self-employed income—or have already paid tax on some income (for example, schedular payments), only the untaxed portion counts toward residual and provisional tax.
Do you have to pay provisional tax? Yes - if you meet the criteria, provisional tax is compulsory.
The only way to avoid it is to have residual tax below $5,000. But that usually means limiting your income, which isn’t exactly a great business strategy.
If you’re required to pay provisional tax and don’t, IRD may charge penalties and interest—and they won’t be shy about getting in touch.
Provisional tax is based on your expected profit for the coming year. There are four calculation methods:
Standard method
The default option. Your previous year’s tax is used, plus an additional 5%. If you don’t choose another method, IRD will apply this one.
Estimation method
You estimate what you expect to earn. This can work well if your income is dropping—but it carries risk if your estimate is wrong.
Ratio method
Tax is calculated as a percentage of your GST returns. This can suit GST-registered businesses with fluctuating income.
AIM (Accounting Income Method)
This method uses software like Xero or MYOB to calculate tax based on real-time profit. It allows smaller, more frequent payments aligned with actual cashflow.
Leave the complexity to an expert - provisional tax can be confusing and getting it wrong can be costly. That’s where expert support makes a real difference.
At Figuration, we keep your accounts up to date, prepare your tax returns, and help you choose the provisional tax method that best suits your business. We’ll also help you stay on track with payment dates, so there are no surprises from IRD.
If you’d like help getting on top of your provisional tax, get in touch with the Figuration team today.