What is income tax?

Published Monday 22 June 2026

Table of contents

• What is the tax-free threshold?
• Types of income tax in Australia
• Income tax rates
• Income tax rates for 2026–27 and beyond
• How to calculate income tax
• Tax deductions for individuals and businesses
• Medicare levy
• Reporting and paying business income tax
• What info does a business need to calculate income tax?
• Simplify your income tax with Xero
• FAQs on income tax

Key takeaways

• Income tax is a government levy on earnings that funds public services; individuals and businesses in Australia must lodge returns declaring their taxable income each financial year.
• Australian residents pay no tax on the first $18,200 they earn (the tax-free threshold), and progressive rates apply to income above that amount, ranging from 16% to 45% for 2025–26.
• You can reduce your taxable income by claiming eligible deductions such as work-related expenses, home office costs, and business operating expenses.
• Cloud accounting software like Xero can help you track income and expenses throughout the year, making tax time simpler and more accurate.

Income tax definition

Income tax is a government levy on the earnings of individuals and businesses. The money collected contributes to public services and infrastructure such as healthcare, education, and transport.

In Australia, the Australian Taxation Office (ATO) administers the income tax system. Individuals and businesses submit tax returns each financial year declaring their taxable income. Staying on top of your tax obligations keeps you compliant and helps you avoid unexpected costs.

What is the tax-free threshold?

The tax-free threshold is $18,200, meaning Australian residents don't pay income tax on the first $18,200 they earn in a financial year. This threshold applies to individuals, sole traders, and partners in a partnership.

If you're an Australian resident for tax purposes, you can claim the tax-free threshold when you start a new job by completing a Tax File Number (TFN) declaration. Non-residents don't have access to the tax-free threshold and are taxed from the first dollar they earn in Australia.

Types of income tax in Australia

The type of income tax you pay depends on your business structure and how you earn your income. Here are the main categories.

Personal income tax

Individuals pay tax on their personal income, including wages, salary, investment returns, and government payments. These taxes are progressive, meaning the rate increases as your income rises through each bracket.

Business income tax for sole traders and partnerships

If you're a sole trader, your business profits (or losses) are combined with your other income and reported on your personal tax return. You pay personal income tax rates on the total amount.

Partnerships generally file a separate business tax return as well, which the ATO checks against the personal returns of each partner. Each partner then pays tax on their share of the partnership income at their individual rate.

Business income tax for companies

Companies pay tax on their net profits at a flat rate rather than progressive rates. The company tax rate is 25% for base rate entities (companies with aggregated turnover under $50 million) or 30% for all other companies. Dividends or salaries the company pays to its owners are then taxed as part of the recipient's personal income.

Capital gains tax

When you sell an asset such as property, shares, or a business for more than you paid, the profit is called a capital gain. In Australia, capital gains are included in your assessable income and taxed at your marginal tax rate. Individuals and small business owners may be eligible for a 50% capital gains tax discount if they've held the asset for more than 12 months.

Income tax rates

Australia uses a progressive tax system for individuals, which means you pay different rates on different portions of your income. Here are the current Australian resident tax rates for the 2025–26 financial year.

• 0% on income from $0 to $18,200 (tax-free threshold)
• 16% on income from $18,201 to $45,000
• 30% on income from $45,001 to $135,000
• 37% on income from $135,001 to $190,000
• 45% on income over $190,000

You only pay the higher rate on the portion of income that falls within each bracket. For example, if you earn $50,000, you don't pay 30% on the full amount; you pay 0% on the first $18,200, 16% on the next $26,800, and 30% on the remaining $5,000.

Income tax rates for 2026–27 and beyond

The Australian Government has legislated changes to income tax rates that take effect from 1 July 2026. These changes reduce the rate on the second bracket, putting more money back in taxpayers' pockets.

For the 2026–27 financial year, the key change is that the 16% rate on income from $18,201 to $45,000 drops to 15%. All other brackets and rates remain the same. From 1 July 2027, this rate is scheduled to drop further to 14%.

These changes apply to individuals, sole traders, and partners. Company tax rates are not affected by these changes.

How to calculate income tax

The basic formula to calculate income tax is straightforward: taxable income multiplied by the tax rate. For progressive taxes, you'll need to apply different rates to each portion of your income that falls within each bracket.

Example: flat rate company tax calculation

A base rate entity company has revenue of $240,000 and expenses of $140,000. The company tax rate is 25%.

Taxable income (revenue minus expenses) multiplied by the tax rate:

($240,000 minus $140,000) x 25% = $100,000 x 0.25 = $25,000

The company owes $25,000 in income tax. If the company distributes after-tax profits to its owners, they'll need to declare that income on their personal tax return as well.

Example: progressive individual income tax calculation

An individual earns $70,000 in wages and makes $30,000 in profits from a sole trader business, for a total taxable income of $100,000. This income touches 3 tax brackets under the 2025–26 rates.

The tax is calculated on each bracket:

• 0% on the first $18,200 = $0
• 16% on the next $26,800 ($18,201 to $45,000) = $4,288
• 30% on the remaining $55,000 ($45,001 to $100,000) = $16,500

Total income tax owed: $0 + $4,288 + $16,500 = $20,788. This doesn't include the Medicare levy, which is calculated separately.

Tax deductions for individuals and businesses

Tax deductions reduce your taxable income, which means you pay less tax overall. You can only claim deductions for expenses directly related to earning your income, and you need records to back up every claim.

Common deductions for individuals include:

• Work-related expenses such as uniforms, tools, and equipment
• Home office costs if you work from home (either the fixed rate method or actual expenses method)
• Vehicle and travel expenses for work-related trips (not commuting to your regular workplace)
• Self-education expenses directly related to your current employment
• Phone, internet, and computer expenses used for work

If you run a business, you can also claim deductions for operating expenses. These include rent, utilities, insurance, marketing costs, professional fees, and depreciation on business assets. Keeping accurate records and tracking business expenses throughout the year makes it much easier to claim everything you're entitled to at tax time.

Medicare levy

The Medicare levy is a 2% charge on your taxable income that helps fund Australia's public healthcare system. Most Australian residents pay the Medicare levy on top of their income tax.

If you earn below a certain threshold, you may pay a reduced levy or no levy at all. The ATO adjusts these thresholds each year, so it's worth checking the latest Medicare levy thresholds on the ATO website.

High-income earners who don't have an appropriate level of private hospital cover may also need to pay the Medicare levy surcharge. This ranges from 1% to 1.5% on top of the standard 2% levy, depending on your income and family status.

Reporting and paying business income tax

All businesses pay income tax only on their net profit (before taxes). When lodging a return, you're expected to report revenue and expenses, and may be asked to provide copies of the corresponding invoices and receipts.

The deadline for lodging your individual tax return is 31 October each year if you lodge it yourself. If you use a registered tax agent, you may be eligible for an extended deadline; your agent can confirm the specific date. Companies have different lodgement dates depending on their circumstances.

Businesses may also need to prepay taxes in instalments throughout the year through the Pay As You Go (PAYG) instalments system. This helps you avoid a large end-of-year tax bill. PAYG instalments are typically based on your most recent tax return or your projected earnings for the current year.

What info does a business need to calculate income tax?

Calculating your business income tax accurately starts with having the right financial records in place. You'll need a clear picture of your revenue and expenses for the financial year.

The key information includes:

• Revenue and expenses, found on the income statement (also known as a profit and loss statement)
• Depreciation schedules for assets owned by the business
• Records of any tax credits, offsets, or prepaid PAYG instalments that can be subtracted from the tax owed
• Bank statements and receipts to support your claims

Xero Accounting Software can simplify your income tax preparation by capturing transaction data (including copies of invoices and receipts through Hubdoc), automating depreciation calculations, and generating financial reports. It's also a good idea to get support from a tax professional; you can find one in the Xero advisor directory.

Simplify your income tax with Xero

When your financial records are organised throughout the year, tax time becomes a straightforward process.

Xero keeps your income, expenses, and receipts in one place, so you have the information you need when it's time to lodge your return. With automated bank feeds, real-time reporting, and easy collaboration with your tax agent, you can approach tax season with confidence. Get one month free.

FAQs on income tax

Here are answers to some frequently asked questions about income tax in Australia.

What is the difference between gross income and taxable income?

Gross income is the total amount you earn before any deductions or adjustments. Taxable income is your gross income minus any allowable deductions, and it's the figure the ATO uses to calculate how much tax you owe.

Do sole traders pay a different tax rate to employees?

Sole traders pay the same progressive individual tax rates as employees. The difference is that employees have tax withheld from each pay, while sole traders typically pay through PAYG instalments and settle any remaining amount when they lodge their return.

Can you claim the tax-free threshold on more than 1 job?

You can only claim the tax-free threshold from 1 employer. If you have multiple jobs, you should claim it from the employer that pays you the most, and your other employers will withhold tax at a higher rate.

What happens if you miss the 31 October lodgement deadline?

The ATO may charge a failure to lodge on time penalty, which accrues for each 28-day period your return is overdue. Contacting the ATO early to explain your situation can help, as they may offer remission of the penalty in some cases.

What happens if you don't pay your income tax on time?

The ATO charges a general interest charge on any outstanding tax debt from the due date. If you're having difficulty paying, it's best to contact the ATO early, as they may offer a payment plan to help you manage the amount owed.