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Income Arrears tax offset

When your back pay takes you into a higher tax bracket, then you will appreciate the income arrears tax offset

If the lump sum arrears payment increases your assessable income by more than 10% you may get the offset

What kinds of income can be included in lump sum arrears?

When your back pay takes you into a higher tax bracket, then you will appreciate the income arrears tax offset

You will recall that receipts are included in assessable income when they are derived.

You will also recall that businesses can accrue income - in other words they can derive income when they recognise it in their accounts, even if they have not yet received the hard, cold cash.

However, for many kinds of income received by individuals, such as salary, you are taken to derive that income when you actually receive it.

So if your boss underpaid you last year, the back payment will be added to your current year assessable income even though it was earned during a previous year.

This could end up costing you money, if the back payment takes you into a higher marginal tax rate bracket.

That is the evil the income arrears offset is intended to remedy.

If a lump sum which was actually derived in an previous year is treated as having been derived in the current year, then an offset will be allowed to cover the additional tax this has added to your liability.

Paragraph 17-350 of the CCH Master Tax Guide has full details of the offset.

If the lump sum arrears payment increases your assessable income by more than 10% you may get the offset

Section 159ZRA allows the offset to a natural person (not a trustee) if

the assessable income of the taxpayer of the current year of income includes one or more eligible lump sums; and

the total arrears amount is not less than 10% of the normal taxable income of the current year

How much offset do you get?

Under section 159ZRB, the rebate is

Tax on arrears - Notional tax on arrears

where:

Tax on arrears is the difference between the tax you would have paid if the lump sum had not been included and the tax you are liable for after the lump sum has been included

Notional tax on arrears is the total of the notional tax amounts for the accrual years.

To make things as simple as possible, the notional tax is broken up into

Recent accrual years (the last 2 years) - dealt with by section 159ZRC

Distant accrual years (more then 2 years previous) - dealt with by section 159ZRD

Notional tax for recent accrual years is the amount of tax which would have been paid if the amount which accrued in those years had been taxed when it accrued.

Notional tax for distant accrual years is the amount which accrued later than 2 years ago, multiplied by the average rate of tax applicable to the recent accrual years amount

So to calculate the rebate,

Calculate tax on arrears. In other words, calculate the extra tax you will pay because of the lump sum arrears (tax on taxable income less tax on taxable income after having deducted the lump sum arrears)

Calculate notional tax for recent accrual years. Get your old tax records and work out how much extra tax you would have paid in the previous 2 years if the arrears now being included in the current year had actually been included in each of those 2 years.

Calculate notional tax for distant accrual years Multiply the average tax rate for the most recent 2 years by the amount of arrears that relates to a period more than 2 years previous

Tax on arrears LESS Notional tax on (recent + distant) arrears

What kinds of income can be included in lump sum arrears?

(a) salary or wages to the extent to which they accrued during a period ending more than 12 months before the date on which they are paid;

(b) salary or wages paid to a person after re-instatement to duty following a period of suspension of the person from duty, to the extent to which the salary or wages accrued during the period of suspension;

(d) an educational or training allowance paid by the Commonwealth;

(e) a payment that is covered by Division 1AA, but that is not exempt from income tax under that Division; or

(f) a payment under a law of a foreign country that is similar to a payment covered by paragraph (e);

but does not include so much of any such amount as was taken into account in calculating the amount of a tax reimbursement payment by the Commonwealth that was authorised under section 34A of the Audit Act 1901;