Decoding Tax Codes: A Payroll Guide for Employers and Employees

Tax codes are more than just a random assortment of letters. They’re important so that employees are taxed correctly, which keeps everyone compliant with New Zealand’s tax regulations. In this blog post, we’ll explore the intricacies of tax codes in New Zealand, breaking down what they are, who they apply to, and how to avoid common mistakes.

What Are Tax Codes and Why Are They Important?

Tax codes are essentially a set of instructions from the Inland Revenue Department (IRD) that instruct the employer, or in most cases, a payroll system, how much tax to deduct from an individual’s income, with relation to their earnings.

You want to make sure to get the tax code right for a few reasons:

Legal Compliance: Incorrect tax codes can lead to underpayment or overpayment of tax, which will result in a tax bill for the employee at the end of the tax year (31st March) from the IRD.

Employee Satisfaction: No one likes unexpected tax bills or feeling like they’ve overpaid. Accurate tax codes help maintain a positive work environment.

Streamlined Payroll: The right tax code simplifies the payroll process, making it easier to manage and less prone to errors.

High Non-declaration Rate: Failing to choose an appropriate tax code can result in being placed on a non-declaration rate, which has a high withholding rate of 45%.

It is important to note, though, that choosing the correct tax code is not the employer’s responsibility to bear. It is up to the employee to notify the employer of their correct tax code. Employers may get in trouble if they try to assume the employee’s tax code. So it’s completely in the employee’s hand to provide the employer with the correct tax code if they want to avoid the non-declaration rate.

Different Tax Codes in New Zealand and Who They Apply To

New Zealand has a variety of tax codes, each designed for specific circumstances. These codes vary based on an individual’s earnings and the nature of their income—main or secondary.

Main Tax Codes

You’ll likely encounter the “M” and “ME” codes most often. These codes are designed for those whose earnings come primarily from one job.

M: This means this occupation is the employee’s main source of income. Therefore their PAYE for their earnings should be calculated according to each relevant tax bracket, and not a flat tax rate. This is the most common tax code that you’ll see.

ME: This also means this occupation is the employee’s main source of income, but they earn less than $48,000 per year. Therefore their PAYE for their earnings should be calculated according to each relevant tax bracket, and not at a flat tax rate. The special designation helps determine the employee’s eligibility for benefits such as the Independent Earner Tax Credit (IETC), which could allow them to receive up to a $10 tax credit per week.

Secondary Tax Codes:

Any code starting with an “S” indicates a secondary income. So, if an employee is on the M code for their main job and picks up a second source of income, that extra income will be taxed under a different code. The rate for this secondary tax code is determined based on their main income.

SB: This means this occupation is the employee’s secondary source of income, but they earn $14,000 or less across all sources of income, and therefore their PAYE should be taxed at a flat rate of 10.5% (excluding the ACC Earners’ Levy) for any payments.

S: This means this occupation is the employee’s secondary source of income, but they earn between $14,001 and $48,000 across all sources of income, and therefore their PAYE should be taxed at a flat rate of 17.5% (excluding the ACC Earners’ Levy) for any payments.

SH: This means this occupation is the employee’s secondary source of income, but they earn between $48,001 and $70,000 across all sources of income, and therefore their PAYE should be taxed at a flat rate of 30% (excluding the ACC Earners’ Levy) for any payments.

ST: This means this occupation is the employee’s secondary source of income, but they earn between $70,001 and $180,000 across all sources of income, and therefore their PAYE should be taxed at a flat rate of 33% (excluding the ACC Earners’ Levy if relevant) for any payments.

SA: This means this occupation is the employee’s secondary source of income, but they earn over $180,000 across all sources of income, and therefore their PAYE should be taxed at a flat rate of 39% for any payments.

Here is a table of what secondary income will be taxed based on their annual main income.

Other Tax Codes

Not all jobs fit neatly into the categories of “main” or “secondary” income. These special tax codes ensure that your unique employment circumstances are accurately reflected in your tax withholdings.

CAE: This relates to Casual Agricultural Employment, however, do not get this confused with the NSW tax code. If you employ an individual for agricultural work for a short fixed-term period, then their tax code should likely be CAE. This means their PAYE is taxed at a flat rate of 17.5% (excluding the ACC Earners’ Levy) for any payments, similar to the S tax code.

NSW: This relates to Non-resident Season Workers. This is primarily used for individuals under the Recognized Seasonal Workers (RSE) scheme, but it could also apply to other industries if the employee is employed fixed-term as a non-resident. This means their PAYE should be calculated at a flat rate of 10.5% (excluding the ACC Earners’ Levy) for any payments, similar to the SB tax code.

EDW: This relates to Election Day Workers. This would not relate to most forms of employment, however it means that their PAYE should be calculated at a flat rate of 17.5% (excluding the ACC Earners’ Levy) for any payments, similar to the S tax code.

Student Loan

SL: This is not a tax code in itself, but it simply means the employee has a student loan. The SL can be added on to any “M” or “S” tax codes, depending if the employee has a student loan or not.

Tailored Tax Code

It’s worth noting that even with the correct tax code, the exact tax amount is rarely deducted unless you’re receiving a fixed, consistent income. Tax codes are designed to estimate your annual earnings, and if your work schedule or income varies, this estimate can be off the mark. That’s why most people end up with either a tax bill or a refund at the end of the tax year.

If you find yourself consistently receiving a tax bill, you might consider applying for a tailored tax code through the IRD. This allows for a more accurate estimate of your annual income, reducing the likelihood of an end-of-year tax bill.

How to Determine the Correct Tax Code for Employees

Determining the correct tax code is primarily the employee’s responsibility. While employers can guide them on where to find the necessary forms, it’s really up to the employee to figure out their tax code and inform their employer.

If you’re an employee and need to know how to make sure your correct tax code is set up when you onboard, here’s how to go about it:

Start with the IRD: Your first stop should be the Inland Revenue Department (IRD). They offer a detailed guide and a tax code declaration form, known as the IR330. While it’s not the employer’s role to choose your tax code, they can point you to where you can find this form.
- Online Option: The IRD website has an online tool that asks a series of questions about your income and circumstances. At the end of the questionnaire, it suggests the most appropriate tax code for you.
Employee Declaration: Once you know your tax code, it’s your job to inform your employer or the appropriate HR department. This is often done as part of a new employee file. If you don’t need to fill out an employee file, make sure to communicate your tax code to your employer through other means, whether that’s through an email or even just a text if that’s how you communicate with your employer.
- Paper or Digital Forms: Whether your employer uses paper forms or digital platforms, you might need to submit the IR330 form to make it official.
Review and Update: Life changes, like getting a student loan or a second job, can affect your tax code. Make it a habit to review your tax code when significant changes happen.
IRD Notifications: If you end up using the wrong tax code, the IRD will first notify you. If no change is made, they’ll then notify your employer.

By following these steps, you can ensure that you’re on the most appropriate tax code, making tax time a breeze and keeping your payroll smooth.

Common Tax Code Mistakes

Using the Wrong Code: This is the most common mistake and can lead to the IRD notifying you to make a change. Always consult the IRD if you’re unsure. Note that in some cases, if you insist on using a different tax code because you believe the one assigned to you is not correct, the IRD may allow your employer to follow your instruction over the IRD’s.

Failure to provide Tax Code: If you fail to provide your tax code to your employer, then your employer can justifiably put you on the non-declaration rate.

Not Updating Codes: Life happens—marriage, new jobs, and other big changes can mean your tax code needs a tweak. Make sure to update as needed to avoid any end-of-year surprises. In most cases, tax codes will need to change when you start earning more.

Ignoring Student Loans: If you or an employee has a student loan, remember to add “SL” to the primary tax code. This ensures the right amount is being paid back.

While incorrect tax codes can create complications, it’s worth noting that the responsibility primarily lies with the employee to provide the correct tax code. The Inland Revenue Department (IRD) generally doesn’t hold the employer accountable for errors, especially since employees often end up with a tax bill or refund at the end of the tax year regardless of the code used.

FAQs on Tax Codes in New Zealand

Here’s some of the most frequently asked questions we get from our customers to our payroll experts. While we’ve touched on some of these topics earlier in the blog, a dedicated FAQ section can serve as a quick and handy reference to reinforce and clarify key points.

What Happens If I Use the Wrong Tax Code?

Using an incorrect tax code can lead to either a tax bill or tax refund at the end of the financial year:

Overpayment: If too little tax is withheld, you may receive a tax bill at the end of the financial year. In this case, the IRD will notify you about the amount owed and the due date for payment. You’ll need to pay this amount by the specified deadline to avoid any further complications. Failure to pay by the due date may result in penalties and interest charges.

Underpayment: On the other hand, if too much tax is taken out, you’ll end up with less take-home pay and may be eligible for a tax refund. The IRD will usually notify you, often through your online myIR account. Refunds are often automatically deposited into your bank account if the IRD has your details, but in some cases, you may need to manually claim your refund.

Who Is Responsible for Making Sure I Use the Right Tax Code?

Employer: The employer’s primary responsibility is to ensure that employees are taxed correctly based on the tax code provided. They collect the IR330 form if required from new hires and update the payroll system to reflect the correct tax code.

Employee: It’s up to the employee to provide the correct tax code. Employees should also notify their employer to update their tax code whenever their circumstances change, such as after getting a student loan or taking on a second job.

What If I Don’t Have My Tax Code?

If you fail to provide a tax code to your employer, they have the option to use what’s known as the “non-declaration rate” for your tax withholding. This rate is generally set at a higher percentage, currently at 45%. The idea behind this elevated rate is to protect both the employer and the government from potential underpayment of taxes. However, it usually results in significantly higher tax withholding from your pay, which is why it’s considered a harsh measure.

A more lenient and commonly used approach is for employers to default to the “M” tax code until you can provide the correct one. This ensures that you’re not overtaxed while you sort out your proper tax code. It’s in your best interest to resolve this as quickly as possible to ensure that you’re being taxed at the appropriate rate.

Simple Tax Code Management with Payroll Software: Why Choose Crystal Payroll

Tax Efficiency with Payroll Software

From easy employee onboarding to automated tax calculations, a good payroll system can be a game-changer when it comes to managing tax codes and ensuring accurate, timely filings.

Why Crystal Payroll is Your Best Choice

Crystal Payroll is designed to be feature-rich, aiming to provide you with the best payroll experience possible. That’s why we’ve focused on making tax code management simple, straightforward, and error-free. With our system, you can confidently say goodbye to tax code mistakes. Here’s what we offer:

Employee Onboarding and Offboarding

The tax code is one of the first things that should be sorted during the employee onboarding process. Establishing the correct tax code from the outset helps in accurate tax withholding, which in turn streamlines the payroll process and minimizes the risk of future tax-related issues. Similarly, during offboarding, the tax code helps in calculating final pays, including any holiday pay, bonuses, or other entitlements.

From the moment you set up a new employee in our system, you’ll find that handling tax codes is straightforward and efficient. During the initial employee setup, you won’t be overwhelmed with options. The system simply prompts you to select the appropriate tax code for the employee. With just one click, a series of calculations occur in the background, ensuring that the correct amount of PAYE is deducted from each paycheck.

Easy Tax Code Updating

Mistakes happen, and when they do, our user-friendly settings allow employers to easily update an employee’s tax code. These changes take effect from the next pay-run, keeping your payroll accurate and up-to-date. If you’ve already processed and filed a pay-run with an incorrect tax code, you have the option to amend and re approve those periods. However, in most cases, it’s advisable to let the IRD handle any adjustments, as they can determine whether the employee is due for a tax refund or owes additional taxes at the end of the year.

Payday Filing

With features like Payday Filing, Crystal Payroll can automatically send the required tax information to the IRD every payday. This real-time reporting not only simplifies the filing process but also ensures that the tax codes are applied correctly for each pay cycle.

Tailored Tax Calculations

For employees with unique tax situations, such as tailored tax codes or multiple income streams, our payroll software can handle these complexities with ease.

Record-Keeping and Auditing

Good payroll software like ours maintains a detailed record of all transactions, including tax withholdings based on each tax code. This is invaluable during an audit or when you need to backtrack and verify historical data.

Choose Crystal Payroll to ensure your pay-runs are not only taxed correctly but also filed in compliance with New Zealand’s tax regulations.

Disclaimer: This blog post is intended for informational purposes and should not be considered as financial or legal advice. Always consult with professionals for tailored guidance.

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