Provisional tax (also known as prov tax) is usually the least understood and most confusing of all the sole trader taxes. But don't worry, this article will take you through what provisional tax is, how it works and how you can use Solo to master your provisional tax.

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Provisional tax is not a seperate tax from income tax. Provisional tax is simply payments of your income tax during the financial year so that you don't have to pay all of your income tax in one big payment at the end of the financial year – it should really be called 'provisional payments' instead of a tax.

Provisional tax payments are usually 4-monthly (3 per year), or 6-monthly (2 per year) if you have 6-monthly GST.

If this is your first year being self-employed you don't need to pay provisional tax (but you still have to pay income tax at the end of the financial year).

You have to pay provisional tax if your tax bill was more than $5,000 for the previous financial year.

To be sure if provisional tax applies to you, you can check your myIR account. In your myIR account, click the More... link for Income tax, then click View account registration details. If a 'Prov tax method' is displayed in the list then provisional tax applies to you.

To track provisional tax in Solo, you first need to go to the Settings page and set Provisional tax required to Yes.

Next, select your Provisional tax frequency. 4-monthly is the default provisional tax frequency, unless you file 6-monthly GST. If you file 6-monthly GST then select 6-monthly provisional tax.

More info: How to configure your settings

Once you have enabled provisional tax in your settings, Solo will then automatically calculate your provisional tax and display your provisional tax periods on the Solo Dashboard and on the Taxes page.

In the Tax snapshot on the Solo Dashboard you will see all currently active tax periods. These are tax periods that are either due or the period that you are currently in.

When a provisional tax period becomes due (or overdue), go to the Taxes page to complete/close the period.

Note: When 'Provisional tax' periods are being displayed on the Solo Dashboard, you might not see your 'Income tax' period. This is because your provisional tax is your income tax and displaying both would be a double-up.

On the Taxes page you will see all your tax periods for the current financial year and any periods that will become due within the next 12 months.

Note: When you first enable provisional tax, all of the provisional tax periods for the current financial year will appear. This might be a bit confusing if you're part-way through the financial year and have already paid some provisional tax. Don't worry, Solo has you covered. For instructions on what to do in this this situation, jump to the section What if I've already paid some provisional tax?

When a provisional tax period becomes due:

Note: The 'Pay' button will only be displayed once the period is due. If a period is currently active, but not yet due, you will see a 'Preview' button instead.

Next, follow the instructions that are shown when you click the 'Pay' button:

When your provisional tax becomes due you need to login to your myIR account and update the IRD's estimate. This is because the IRD doesn't know how much you have earned in the period, so they estimate your provisional tax based on what you earned in the previous year. However, Solo calculates your provisional tax based on what you have actually earned.

Note: You can choose to pay the provisional tax amount that Solo has calculated or pay the amount that IRD estimated.

To update the IRDs estimate in your myIR:

Note: When paying the provisional tax amounts that Solo calculates, you shouldn't need to pay any additional income tax at the end of the financial year (because you would have already paid the exact amount of income tax as provisional payments). Overpaying your provisional tax will result in a refund at the end of the tax year. Underpaying your provisional tax will result in paying income tax for the amount you underpaid.

After you've updated the provisional tax amount in myIR, you next need to pay your provisional tax to IRD.

Note: Solo doesn't handle any tax payments to the IRD. Tax payments need to be made outside of Solo directly from you to the IRD.

To make a provisional tax payment to the IRD, visit your online banking website and use the "pay tax" function to pay the IRD. Select 'INC - Income Tax or Provisional Tax' as the tax type and remember to enter your IRD number in the particulars.

Solo calculates provisional tax in the same way that it calculates income tax – based on your taxable profit and the income tax brackets.

If you have your IRD feed connected Solo will automatically take into consideration any tax that has already been paid on income that appears in your IRD feed. However, the IRD feed doesn't tell Solo how much provisional tax you have paid. So if you have already paid some provisional tax for the current financial year when you set up your Solo account, you will need to enter the amount of provisional tax that you have paid.

The big problem with provisional tax is that it's estimated by the IRD. The IRD estimates provisional tax based on what you earned last year and then requires consistent payments during the year. However, if your income is inconsistent and it drops compared to last year or you have a slow few months, you will be paying a disproportionate amount of tax compared to what you earned. And no one wants to pay tax on money they haven't even earned.

To solve this problem Solo has created a unique way of calculating provisional tax in real-time so that you only pay tax on the money you have actually earned – rather than paying based on an estimate.

The IRD currently has 4 options for working out your provisional tax; Standard option, Estimation option, Accounting income method (AIM) and Ration options.

The Standard option and Ratio option are both estimated based on your previous year. The Estimate option is more flexible and can be updated based on what you expect to earn for the year. The Accounting income method (AIM) does calculate your provisional tax as you go, but it has some drawbacks.

Solo's approach uses the Estimate option to provide the benefits of AIM, but without the drawbacks. By using the Estimate option you only pay tax on the income you have actually earned, the same as with AIM. But unlike AIM, you don't need to file additional paperwork every two months. Solo's approach means you still have the flexibility to pay provisional tax 4-monthly/6-monthly and you don't have any additional paperwork.

The downside is that you need to login to your myIR and update your provisional tax estimate when your provisional tax period becomes due.

When you first start using Solo you'll probably notice that the provisional tax amount that IRD provides is different to the amount calculated in Solo – sometimes very different. This is expected and also a good thing.

The reason for the different amounts is that the IRD only estimates provisional tax based on what you earned last year. Solo however, calculates your provisional tax based on what you have actually earned. This means that you only pay tax on the income you have earned and you don't get caught out paying unnecessarily high estimates.

You can learn more about Solo's unique approach to provisional tax in the section above.

When you start using Solo you might have already paid some provisional tax for the financial year. Or you might prefer to pay the amount that the IRD has estimated rather than the amount Solo has calculated. Here's what to do in this situation:

The provisional tax period will then be closed and the amount that you enter will be used in Solo's calculations to make sure future provisional tax payments are still accurate. You can undo a closed period at any time by clicking on the 'History' tab in the Taxes page.

Your Schedular payment and PAYE income, as well as any tax that's already been paid on this income, is taken into consideration when Solo calculates your provisional tax.

Because tax is paid at a flat rate on Schedular payment and PAYE income, a disproportionally high amount of tax is paid early in the financial year (when your income is in the low tax brackets). This means that sometimes Solo can display a negative amount for provisional tax early in the financial year. Although a negative amount suggests you are due a refund, you cannot get a provisional tax refund during the year. So use 0 when completing the provisional tax period and the negative amount will be subtracted from your next provisional tax period.

I hope this article has answered all your provisional tax questions and given you a better understanding of how provisional tax works. As always, if you have any further questions please send a message though the in-app chat and we will be happy to help.