Chartered Accountant Timothy Quinn leads Tax & Accounting at Lawpath. 16+ years in tax advisory, specialising in startup growth and expansion. Passionate about supporting entrepreneurial clients with early-stage investment incentives, restructuring, international exit strategy planning, and more.
Lump sum payments, such as back payments, bonuses, and employment termination payments, require precise tax calculations to ensure compliance and avoid penalties. As an employer, you must accurately determine the type of payment, apply the correct tax rates, and report these payments through Single Touch Payroll (STP).
Navigating these processes in accordance with the rules set out by the Australian Taxation Office (ATO) can be confusing.
We’ve written this guide to help you along the way. Read on to learn how to calculate tax on lump sum payments, understand the different types of payments, and apply the ATO’s guidelines effectively.
Table of Contents
What are lump sum payments?
Lump sum payments are one-time payments made to employees, distinct from regular wages. They include:
- Employment Termination Payments (ETPs)
- Redundancy payments
- Unused leave payouts
- Back payments
These types of payments may have unique tax implications that are different from standard wages.
Employment Termination Payments (ETPs)
You must pay ETPs if your company terminates an employee. These payments can include severance pay, redundancy pay, and other payments related to the termination of employment.
ETPs receive concessional tax treatment to provide financial support for terminated employees. This means that your terminated employees will pay a lower tax rate on ETPs compared with their regular income up to a certain threshold.
Redundancy payments
Redundancy payments are a type of ETP. You will need to pay this to any employees who are made redundant, compensating them for the loss of their jobs due to business restructuring or downsizing.
Like other ETPs, redundancy payments are subject to concessional tax rates, but they must meet specific conditions to qualify for this treatment.
Unused leave payouts
If, upon termination of employment, an employee hasn’t used all of their annual or long service leave, they are entitled to an unused leave payout. These payments are taxed as ordinary income but may be subject to different tax rates depending on the type of leave and the circumstances of the payout.
Back payments
Back payments or payments in arrears are paid for work that employees already performed. This is usually due to underpayments or a change in employment conditions. Since such payments can span multiple years, they sometimes qualify for tax offsets.
The tax treatment for back payments depends on the financial year in which the work was performed and the applicable tax rates for those years.
Employer tax obligations on lump sum payments
You must adhere to strict tax obligations when handling lump sum payments. This includes accurate withholding, reporting, and compliance with ATO guidelines. Let’s take a closer look at these responsibilities.
PAYG withholding requirements
Just like with any other payment, you’ll need to correctly calculate the PAYG withholding for any lump sum payments.
In terms of tax tables, you’ll need to use NAT 3348 for back payments, commissions, and bonuses. Your accounting software should have these tables built in.
If the lump sum is paid for the current financial year, then you should apply Method A for PAYG withholding. In contrast, apply Method B for back payments spanning prior financial years.
There are also some special cases that you need to consider:
- Seasonal workers are taxed at a flat 15% rate, regardless of payment type.
- Working Holiday Makers require the Working Holiday Maker Tax Table, and Method A/B(ii) does not apply.
- Tax withheld via Method A cannot exceed 47%.
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Reporting through Single Touch Payroll (STP)
You must report lump sum payments to the ATO via STP Phase 2. Note that there are specific rules for Lump Sum E (back payments accrued >12 months prior):
- Threshold: Report Lump Sum E if the amount exceeds $1,200 and relates to a prior financial year.
- Allocation: Split payments into the correct financial years. For example, if the total lump sum is a $3,300 back payment spanning 22 months, you should report it as:
- $1,800 (current financial year) under regular allowances.
- $600 (2020–21) and $900 (2019–20) as Lump Sum E.
Employers no longer need to issue lump sum E letters — income statements now automatically reflect these amounts.
Issuing payment summaries
Employers must provide annual payment summaries by 14 July, including:
- Standard summaries: Use PAYG payment summary – individual non-business (NAT 0046) for regular wages and allowances.
- ETP-specific summaries: Issue PAYG payment summary – employment termination payment (NAT 70868) within 14 days of paying an ETP.
Superannuation obligations
Super contributions apply only if the lump sum is classified as Ordinary Time Earnings (OTE). OTE includes regular salary, commissions, or allowances tied to standard hours. If the lump sum is an irregular payment like overtime, then super obligations do not apply.
Penalties for non-compliance
If you fail to submit all paperwork on time or make mistakes in your reporting, the ATO may impose penalties, including additional fees and interest owed. Plus, incorrect reporting can trigger audits by the ATO, which can be stressful.
Here are some frequent mistakes employers make when reporting lump sum payments:
- Using incorrect tax rates or methods (e.g., misapplying Method A vs. B(ii)).
- Failing to split Lump Sum E payments across prior financial years.
- Missing STP reporting deadlines or omitting payment summaries.
To prevent these mistakes from happening, make sure that you have a clear understanding of how the ATO applies taxation to lump sum payments. Make sure to classify and report the payment correctly.
If you are worried about compliance, it might be a good idea to contact a professional tax accountant who can guide you through the reporting process.
How to calculate tax on lump sum payments (employer)
Take the following steps to calculate tax on lump sum payments.
Step 1: Identify the type of lump sum payment
The nature of a lump sum payment will define its tax implications. For example, ETPs are taxed differently from back payments. So, the first step is to determine which type of payment you are processing, which will help you understand how it should be taxed.
Step 2: Determine applicable tax rates and thresholds
Tax rates vary for different types of lump sum payments. For example, there are concessional rates for ETPs up to certain thresholds. In contrast, you’ll need to use the NAT 3348 tax table to calculate taxes on back payments.
Step 3: Apply the correct withholding method
As discussed earlier, if the lump sum payment covers the current financial year, you’ll need to use Method A to calculate PAYG withholdings. To do so:
- Apportion the lump sum over the total number of pay periods in the financial year.
- Add the average amount to the employee’s regular earnings for the current pay period.
- Apply the appropriate tax rate based on the combined income.
Example: If an employee receives a $10,000 bonus in a year with 26 pay periods, the bonus is apportioned as $384.62 per pay period. This amount is added to their regular earnings for the current pay period, and tax is calculated based on the total income.
Reporting and paying tax on lump sum payments
You must report lump sum payments through STP and include them in the correct financial year. Your payment summaries must also reflect these payments.
Remember that the ATO sets strict reporting deadlines. Make sure you report on time, as non-compliance can result in penalties.
Common mistakes employers make when calculating tax on lump sum payments
Employers often encounter challenges when handling lump sum payments, which can lead to errors in tax calculations and compliance issues. Let’s take a look at some common errors and how to mitigate them.
Using the wrong tax rate
One of the most common mistakes is using the wrong tax rate due to misclassified payments or failure to account for employee status. For instance, seasonal workers are taxed at a flat 15% rate, while regular employees follow standard tax tables.
Make sure to verify each employee’s status to apply the correct tax rates. Use the correct tax tables; for example, NAT 3348 is used for back payments, commissions, and bonuses, while Schedule 5 applies to lump sums spanning multiple financial years.
It’s also important to check thresholds, as ETPs have concessional tax rates up to $230,000 (2024–25), with higher rates applying beyond this threshold.
Misclassifying lump sum payments
Misclassifying lump sum payments is another common error. For example, it’s possible to mistreat a Lump Sum E as a regular back payment or confuse redundancy pay with general ETPs.
Understanding the different types of payments is essential; for example, Lump Sum E refers to back payments accrued more than 12 months prior and exceeding $1,200, which must be reported across prior financial years.
Try using payroll software, which will automatically classify payments using pre-built categories, reducing manual errors.
Failing to report correctly
Failing to report lump sum payments correctly through STP or omitting them from payment summaries is a significant mistake. For example, you must report Lump Sum E payments with specific financial year allocations to comply with STP Phase 2 rules.
Double-check any reports before you submit them. If you are unsure if a report is correct, have a tax accountant look over your paperwork.
Another crucial mistake is not submitting by the deadline. Remember that you need to complete the final STP reports by July 14th each year. Meanwhile, ETP payment summaries must be issued within 14 days of payment.
Proactive measures
Taking proactive measures is the best way to prevent these mistakes. For example, you should provide training for your payroll team on ATO guidelines for lump sum payments. You should also regularly audit your payroll systems, making sure that you have set up the correct tax tables and STP settings.
These steps can prevent mistakes altogether, avoiding costly penalties and audits down the line.
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FAQ
What is the difference between lump sum A and lump sum B?
Lump sum A and B typically refer to different methods or categories of payments, but specific distinctions depend on the context. Generally, Method A is used for back payments and bonuses, while Method B(ii) might be used for other specific scenarios.
Can an employer get a tax deduction for lump sum payments?
Employers may be able to claim deductions for certain lump sum payments, depending on their nature and how they are classified for tax purposes.
How do I handle lump sum payments for employees in different tax brackets?
Handling lump sum payments for employees in different tax brackets involves applying the correct withholding method based on their total income, including the lump sum. This may require using tax tables like NAT 3348 for back payments.
Ensuring tax compliance
Accurately calculating tax for lump sum payments is crucial for compliance with ATO guidelines. To do so, carefully categorise payments, apply the correct tax rates, and report them through STP.
If you are facing a complex reporting process and worry about business tax compliance, reach out to Lawpath. We can offer professional support to ensure you meet your tax obligations with full compliance.
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