Onside With The IRD: Preventing Tax Woes on Parental Leave
As a new parent, the last thing you want is a surprise tax bill after going through the financial pinch of parental leave. Here are two common tax issues that new parents can face, and we’ve got the tips on how to avoid them.
If you are concerned about facing a tax bill, contact the IRD for support with paid parental leave.
Issue #1: You are overpaid Best Start payments - and you have to pay the IRD back
You can receive more Best Start payments than you’re entitled to if you underestimate your family income when submitting an estimate to the IRD. The same issue can also apply to the other three types of Working For Families payments, but this problem crops up most often for Best Start payments because all families are eligible in their child’s first year but not necessarily in their child’s second and third years.
The cause
All Kiwi families, regardless of income, receive $69 per week tax-free for the first year of their child’s life via the government’s Best Start program. These payments start after your government parental leave payments stop.
When your child turns one, whether you continue to receive Best Start payments depends on your combined family income and how many children you have under the age of 3. For every dollar your family income is above $79,000, your family’s Best Start payment will be reduced by 21 cents. For example, if your total family income is $80,000 per year and you have one child under the age of 3, you could continue to receive $61 per week while they are between the ages of 1 and 3.
For a detailed table of Best Start payment calculations, use the Working For Families Tax Credit table.
The IRD sends you a notice in the mail when your child turns one asking for an income estimate. Overpayment can happen when your family income exceeds the estimate you submitted to the IRD, and you receive more Best Start payments than you’re entitled to.
This generally happens for two reasons:
You leave out your partner’s income. Best Start payments are based on your family’s combined income, not just yours alone.
You underestimate your combined family income. Your actual family income might be higher because you or your partner receive a bonus, pay rise, annual leave cash out or some other reason that results in more income.
How to prevent this
To prevent overpayment, make sure you include both your and your partner's income when submitting an estimate to the IRD.
In addition, if you anticipate your income will be higher during the year, you could overestimate it. If it turns out to be lower than the estimate, don’t worry - the IRD will square up with you at tax year-end, and you’ll receive a nice little lump sum payment.
Alternatively, you could elect to receive your annual Best Start entitlement as a lump sum payment at tax year-end once you know what your actual annual income is. The downside is that you only get the cash at the end of the year, and you have to wait until both your and your partner’s tax returns have been processed.
Issue #2: You’ve underpaid tax on your earnings during parental leave
If you're receiving paid parental leave from the government and income from your employer (such as parental leave payments or KIT hours), it's important to use the correct tax code. In New Zealand, you must assign one tax code for your main income and a different secondary tax code for your other income. If you use the wrong tax code, you may owe more in taxes at the end of the year.
The cause
Your secondary tax code is based on your total estimated earnings for the year. Your secondary tax rate is equivalent to your marginal tax rate, i.e. the highest tax rate you pay on your income.
Source: IRD website
The issue arises when insufficient tax is deducted from your earnings, resulting in a surprise tax bill at year-end because:
The main tax code is applied to all income sources or
The incorrect secondary tax code is applied.
For example, Anna earns an annual salary of $68,000 and goes on parental leave for six months. Her employer makes top-up payments, so she receives her full salary for 26 weeks (lucky her!).
When Anna applies for parental leave, she reads on the IRD website that she should use the secondary tax rate for the smaller income stream. She assigns the main tax code to her government-paid parental leave (this is correct) and the secondary tax code “S” to her employer top-up (this is incorrect).
Because she’s selected “S”, her employer top-ups are taxed at 17.5%. However, tax code “S” is for people who earn a total annual income of between $14,001 and $48,000. Since Anna earns more than that, she should have picked the tax code “SH” for people who earn between $48,001 and $70,000, and her employer top-ups should have been taxed at 30%. At the end of the tax year, she faces a bill of just over $2,100.
Most of the time, applying the correct secondary tax rate will result in the correct tax bill. However, if your total income from all sources crosses one of the income tax thresholds ($14,000, $48,000, $70,000 or $180,000), then you may still end up overpaying or underpaying tax, which will be addressed at tax year-end. Call or email the IRD if you’re concerned about your tax bill.
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All figures rounded to the nearest dollar
Anna’s weekly salary is $1,308 ($68,000 divided by 52 weeks)
Anna is eligible for government-paid parental leave and receives the maximum amount of $661 per week (check your eligibility here)
Anna receives employer top-ups of $647 per week (her weekly salary of $1,308 less her government-paid parental leave of $661)
Since Anna selected the secondary tax code “S” for her employer top-up, that payment is taxed at 17.5% or $113 per week. Her correct secondary tax code is “SH”, and that payment should have been taxed at 30% or $194 per week. She has underpaid tax of $81 per week on her employer top-ups.
At the end of the tax year, the IRD does a square-up and realises Anna has underpaid tax. They send her a bill for the difference $2,106 (26 weeks x $81 per week of underpaid tax)
How to prevent this
Use the correct tax code for each income stream you receive to avoid a surprise at tax time. You can find your correct tax code on the IRD website. The IRD recommends using the secondary tax rate for the smaller income stream.
Did you encounter a different tax issue during or after parental leave? Let us know in the comments below so we can help other parents!
Now for the important legal part: Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. The information we provide is general and not regulated financial advice for the purposes of the Financial Markets Conduct Act 2013. Please seek independent legal, financial, tax or other advice in considering whether the content in this article is appropriate for your goals, situation or needs. The information in this article is current as at 1 March 2023.
Stephanie Pow
Founder & CEO of Crayon