Understanding Bonus, Back Pay, and Cash Out Payments
The Australian Tax Office (ATO) mandates the way that taxes are calculated on employee earnings. In addition to the taxation of standard earnings, the ATO has specific guidelines on the taxation of special payments, which include:
Bonus payments.
Bonus payments are payments that employees receive in addition to the earnings that they receive for the time that they have worked. For example, an employer might choose to give employees a 500 AUD annual bonus if the company has a profitable year.
Back pay payments, or payments made in arrears.
Back payments are payments that employees receive at a date that is later than when the payment was originally due to them. For example, employee A was supposed to receive a pay increase in January, but the increase was not entered into the system until March. Employee A would then receive a back pay payment to compensate him for the pay increase from the time that it was effective (January) through the time when the increase was entered (March).
Cash out payments of employee leave.
When an employee receives monetary compensation for accrued leave time instead of taking the time off from work, that is considered a cash out payment of leave.
Each of these types of payments is subject to specific tax calculations, as defined by the ATO. To calculate these tax amounts correctly, the system takes into account this information:
Type of payment.
The system uses the pay source from the pay type, or the Back Pay Flag designation on the timecard to determine whether the payment is a bonus, back pay, or cash out payment. Each type of payment is taxed differently.
Employee earnings history.
The system uses payment history to determine how much the employee earned during the time period that is specified on the bonus, back pay, or cash out timecard.
Employee tax history.
The system uses tax history to determine how much the employee has already paid in taxes during the time period that is specified on the bonus, back pay, or cash out timecard.
Timing of the payment.
Though the timing of the payment can affect all three types of payments, the ATO defines three different time periods that are specific to the calculation of back payments. The earnings that are associated with each period are taxed using a different tax calculation method. These methods are used when you are calculating back pay payments:
Method A: The work date is during the current fiscal year.
Method B: The work date is in the previous fiscal year.
Method C: The work date is more than 12 months before the payment date.
Therefore, if an employee receives a back payment for earnings that should have been received, in total, during the previous fiscal year, the system calculates that payment using tax method B. If the payment includes earnings that fall into more than one of these categories, the system prorates the payment amounts and calculates each portion using the correct tax method.
For specific information about the rates and calculations associated with tax methods A, B, and C, contact your local ATO office, or review these ATO publications, which you can access online at www.ato.gov.au:
NAT 3348-9.2004 - Lump Sum Payments in Arrears
NAT 7905-9.2004 - Bonuses and Similar Payments
PAYG Calculation Sheet - Holiday and Long Service Leave Payments for Continuing Employment