Provisional tax, explained simply
If your first year in business went well, provisional tax can come as a surprise — often the year after you’ve already spent the money. Here’s the plain-English version.
What it is
Provisional tax isn’t a separate tax. It’s simply paying next year’s income tax in instalments, rather than in one lump sum. Inland Revenue asks for it once your residual income tax for a year is more than $5,000 — which most growing sole traders and companies reach fairly quickly.
Why the first year stings
In your first year you pay the tax on that year’s profit. Then, because you now have tax to pay, IRD also asks you to start paying towards next year — so it can feel like you’re paying twice. You’re not; you’re just catching up to a pay-as-you-go rhythm.
The three options
There are a few ways to work out what you pay:
- Standard — last year’s tax plus 5%. Simple, but blunt if your income changes.
- Estimation — you estimate this year’s profit. Useful if you expect a very different year, but get it wrong and you may face interest.
- AIM — the Accounting Income Method, which calculates provisional tax through your accounting software as you go. Often the kindest on cashflow.
What actually helps
The single best habit is to set money aside as you earn it, so the bill is never a shock. A rough rule of thumb is to park a percentage of every payment in a separate account — our set-aside calculator gives you a starting figure.
If provisional tax is looming and you’re not sure which option fits, that’s exactly the kind of thing worth a short conversation. You can book a consultation any time.