Provisional tax: standard, estimation, ratio, or AIM?

Once your end-of-year tax bill passes $5,000, Inland Revenue stops waiting until year end, and you pay the following year's tax as you go, in instalments. But how those instalments are calculated is a choice. There are four methods, and the right one depends on how predictable your income is. This guide compares them and covers the safe-harbour rule that decides how much the choice actually costs you.

The standard option: last year plus 5%

This is the default, and what most contractors should use. Your instalments total last year's residual income tax plus 5%, or the year before's plus 10% when last year's return isn't filed yet, split equally across your instalment dates. That's three payments for most contractors, or two bigger ones if you file GST six-monthly.

The idea behind it is to assume this year looks like last year, slightly bigger. When that's roughly true, it's hard to beat, because the amounts are predictable, the dates are known, and there's nothing to monitor. If income jumps, you underpay through the year and settle the difference at terminal tax. If income drops, you've effectively lent Inland Revenue the difference until your refund comes back.

The safe-harbour rule

Read this before you try to optimise anything. Interest is what makes the choice of method matter at all. If your residual income tax ends up under $60,000 and you paid your standard-option instalments in full and on time, Inland Revenue charges no use-of-money interest on any shortfall. You just pay the difference at terminal tax.

For a large share of contractors, that settles the question. Use the standard option, pay on time, and a good year costs you nothing extra until terminal tax day. The finer-grained methods below are mainly worth the extra complexity when your RIT is heading past $60,000 or your income is genuinely uneven.

Estimation: for a year that dropped

You can estimate your own provisional tax instead, and re-estimate through the year up to your final instalment. Estimation exists for one main scenario, which is when income has clearly dropped and paying last year plus 5% would badly overpay. The catch is that if you estimate too low, use-of-money interest applies to the underpayment, because estimating takes you outside the safe harbour. Estimate honestly, keep evidence of your reasoning, and use it when your income has genuinely dropped, not to shave a bit off a normal year.

The ratio option: tax that tracks your invoicing

The ratio option calculates each instalment as a percentage of your actual GST-period sales, so tax tracks income automatically. A big period means a bigger payment, and a quiet period means a smaller one. It's paid in six instalments on the GST cycle, and if you apply it correctly, there's no use-of-money interest even if the year ends short.

Eligibility is specific. You need to:

• have been GST-registered and in business for the whole previous tax year (and part of the year before),
• have previous-year residual income tax over $5,000 and up to $150,000, and
• file GST monthly or two-monthly (six-monthly filers can't use it).

It suits contractors whose income swings within a year and whose margins are steady, because the ratio ties tax to turnover rather than profit.

AIM: pay on actual profit, through software

The accounting income method calculates instalments from your actual accounting income each period, through approved accounting software that files a statement of activity every cycle. Pay what it calculates, on time, and no use-of-money interest applies. It's the closest thing to pay-as-you-earn for the self-employed, at the price of running and paying for the software and keeping to its filing rhythm. For a solo contractor already inside the safe harbour, AIM usually adds process without adding protection. It earns its keep for bigger businesses with uneven income above the $60,000 line.

Choosing, in one pass

• Steady or growing income, RIT under $60,000: use the standard option, pay on time, and you can leave it there.
• Income clearly down on last year: estimate, carefully and with evidence.
• Lumpy income, monthly or two-monthly GST, RIT up to $150,000: the ratio option ties payments to reality.
• RIT past $60,000 with volatile profit: AIM through your accounting software, or a conversation with your accountant about which protection is cheapest.

The dates for every method this year are in the tax calendar, and what provisional tax actually is starts in the hub guide.

How Coffer helps

Whichever method you pay by, the money has to be there on the instalment date. Coffer ringfences income tax from every paid invoice at your projected effective rate, and shows the instalment dates with a countdown. Each provisional payment you log is set against what's ringfenced, so the dashboard always shows whether the next instalment is covered.