Should you claim the tax-free threshold? Here’s how to decide

The tax-free threshold is a key part of the Australian tax system that every taxpayer should understand. It sets the amount of income you can earn before paying income tax. Knowing when and how to claim it can greatly affect your tax liability, take-home wage and overall financial situation. Making the right decision can help you avoid tax debt, optimise your finances and prepare better for tax time.

This guide explains what the tax-free threshold is, who can claim it and the benefits and drawbacks of doing so. We'll also highlight common mistakes and how to avoid them, ensuring you meet your tax obligations.

Introduction to the tax-free threshold

TAX FREE word with in form of stacked blocks

The tax-free threshold allows Australian residents to earn up to $18,200 per income year without paying income tax. This threshold, applicable for the 2023-24 financial year, plays a significant role in reducing the tax liability for low to moderate earners. As part of Australia's progressive tax rates, the system ensures that those earning below this amount don't face any tax burden, easing financial pressure on lower taxable incomes.

If your total income exceeds $18,200, you are only taxed on the portion that goes beyond the threshold. For instance, if you earn $25,000 in a year, only the excess $6,800 will be taxed, at the applicable tax rate. This structure effectively reduces your taxable income, meaning tax is only paid on what you earn above the threshold, offering an automatic tax deduction for low earners. Understanding this system can help you make better decisions about whether to claim the threshold, especially if your combined income from multiple sources affects your overall tax obligations.

Eligibility criteria

To claim the tax-free threshold, you must meet specific eligibility criteria. The primary requirement is being classified as an Australian resident for tax purposes. Non-residents are not eligible and must pay income tax on every dollar earned in Australia — regardless of their income level.

Several special circumstances can also affect your eligibility:

• Multiple jobs: If you have more than one job, you should only claim the tax-free threshold for the job where you earn the most wage or annual income. Claiming it for multiple jobs can result in underpaying your taxes throughout the year, leaving you with a tax debt or unexpected tax bill when you file your income tax return.
• Change of employment: If you switch jobs during the income year, it's important to update your TFN declaration with your new employer to ensure your tax withholding reflects your current income situation.
• Receiving income from pensions or allowances: If you receive a government pension or taxable income from allowances along with a job, you can only claim the tax-free threshold from one source of income.
• High-income earners: For individuals earning a higher income, it might be more beneficial to explore other tax offsets or deductions, rather than relying solely on the tax-free threshold. The low-income tax offset (LITO), for instance, could provide some relief, but high-income earners may benefit from additional tax planning strategies like maximising tax deductions or considering private health insurance for tax benefits.
• Non-resident considerations: As non-residents are taxed on every dollar earned, they should be aware that claiming the tax-free threshold is not available to them. Instead, their tax rate starts from the first dollar earned in Australia, which may impact their tax obligations significantly.

For those with complex income streams, such as multiple jobs or higher incomes, other tax strategies may be more effective in managing your tax liability. For more information, check out How to Reduce Tax for High-Income Earners.

Should I claim the tax-free threshold?

Claiming the tax-free threshold offers significant benefits, especially for those earning lower or moderate incomes. By reducing the amount of income tax withheld from each paycheck, you can maximise your take-home pay throughout the year and avoid overpaying on taxes. Here's a concise breakdown of who should claim the tax-free threshold:

1. Low-income earners: If your annual income is less than $18,200, you should claim the tax-free threshold to ensure no tax is withheld from your earnings. This helps you keep all of your income without unnecessary tax deductions.
2. Primary jobholders: If you have one job and your income exceeds $18,200, claiming the tax-free threshold ensures that only the income above the threshold is taxed. This means less tax withheld, which boosts your immediate take-home pay and improves cash flow for everyday expenses.
3. Part-time workers: If you work part-time and earn below or just above the threshold, claiming it allows for better management of your taxes. You can keep more of your paycheck and avoid overpaying on taxes during the year.
4. People transitioning between jobs: If you've switched jobs during the financial year, you should claim the threshold on your new job, provided you haven't already claimed it on your previous employer's tax file number declaration.
5. Long-term planners: Claiming the tax-free threshold can help avoid overpaying taxes and might result in a tax refund when you lodge your income tax return. This can contribute to better financial planning and saving strategies over the year.

In summary, claim the tax-free threshold if:

• You earn below $18,200.
• You only have one job.
• You want to reduce the amount of tax withheld from your paycheck.
• You want to avoid overpaying taxes and potentially receive a tax refund.

For more personalised tax advice, consider consulting a registered tax agent to help optimise your tax strategy.

The drawbacks of claiming the tax-free threshold

While claiming the tax-free threshold offers benefits, it can cause issues if not managed carefully. Here are some key drawbacks to consider:

Underpayment of taxes

If you claim the tax-free threshold on more than one job or fail to account for extra income, you might underpay your taxes. This could result in a tax debt when you file your income tax return, as you'll need to pay back any shortfall to the Australian Taxation Office (ATO).

Tax debt from multiple jobs

Claiming the threshold on two or more jobs can lead to under-withholding of tax, leaving you with a tax bill at the end of the financial year. To avoid this, only claim the threshold on the job where you earn the most, and ensure your other jobs apply the "no tax-free threshold" rate.

Income changes

Receiving bonuses, switching to a higher-paying job, or taking on extra work can push you into a higher tax bracket, increasing your tax liability. Regularly reviewing your tax declaration and adjusting if necessary can prevent unexpected debts at tax time.

How to claim the tax-free threshold

Calculating financial data.

Claiming the tax-free threshold is a relatively simple process, but it's important to follow the correct steps to ensure you're meeting your tax obligations.

1. Fill out a TFN Declaration Form: When you start a new job, your employer will provide you with a TFN Declaration Form. This form asks whether you want to claim the tax-free threshold. If you are eligible and earning under $18,200 for the year, select "yes."
2. Submit the form to your employer: Once you've completed the form, submit it to your employer, who will then adjust the amount of tax withheld from your pay accordingly.
3. Review your income: Regularly review your income throughout the year. If you start earning more than anticipated or take on additional work, you may need to update your tax information to ensure the correct amount of tax is being withheld.

To make sure you're accurate, visit the ATO's official guide on how to claim the threshold at ATO Tax-Free Threshold Guide.

Common mistakes and misconceptions

There are several common mistakes and misconceptions regarding the tax-free threshold that can lead to financial complications.

One major misconception is that claiming the tax-free threshold will automatically result in a larger tax refund. While it reduces the amount of income tax withheld during the year, your actual refund depends on factors such as your total income, tax deductions and applicable tax offsets.

Another frequent mistake is claiming the tax-free threshold on multiple jobs, which can result in underpayment of taxes and a tax debt when you file your income tax return. Additionally, many taxpayers fail to update their tax information after a job change or neglect to review their earnings from multiple sources.

To avoid these issues, it's important to regularly assess your tax withholding and income situation throughout the year to ensure you meet your tax obligations and avoid surprises at tax time.

Key takeaways

The tax-free threshold can significantly affect your tax liability and take-home pay, but it's important to understand when and how to claim it. By following the right steps and regularly reviewing your financial situation, you can avoid tax pitfalls, optimise your take-home pay and reduce the risk of a tax bill at the end of the year.

For professional advice tailored to your specific situation, consider reaching out to a registered tax agent or exploring Tax Planning Services to ensure you're making the best financial decisions possible.