Understanding Tax Directives, common misconceptions

Tax directives are an attractive solution for commission earners and other employees with fluctuating incomes. However, what are the implications if you incur unexpected tax liabilities? Let’s go into further detail and break down the essential points about tax directives, how they work, common misconceptions, and what you should know before applying.

 

What is a Tax Directive?

 

A tax directive is a formal instruction from the South African Revenue Service (SARS) that allows you to fix your tax bracket for a specific tax year. Typically, your employer calculates your tax based on income and applies the appropriate rate from the progressive tax tables. However, for individuals with variable incomes—like commission earners—a tax directive can provide some predictability by fixing the tax rate on your earnings throughout the year.

 

The Importance of Fixing Your Tax Bracket

 

Fixing your tax bracket with a directive is a way to save on taxes, especially if you anticipate earning significantly more in one month than in others. For instance, if you earn a modest amount for most of the year but receive a hefty commission at the end, fixing your tax at 18% might sound appealing. However, the tax you pay with a directive is provisional. SARS will perform a reconciliation at the end of the tax year to determine if you’ve underpaid or overpaid your taxes.

 

Common misconceptions about Tax Directives

 

One of the biggest misconceptions about tax directives is the belief that once you’ve fixed your tax bracket, that’s the total tax you’ll owe for the year. This is not true. While a tax directive fixes the tax rate applied to your earnings during the year, it doesn’t absolve you of your obligation to pay the correct amount of tax based on your total annual income. 

 

If your income for the year places you in a higher tax bracket, you will still need to pay the difference during the year-end reconciliation.

 

For example, say Sam earns R20,000 monthly, with a 5% increase in January, taking his gross income to R21,000. If Sam uses a tax directive to fix his tax at 18%, he might pay less during the year. However, during reconciliation, if Sam’s total income places him in the 26% bracket, he must pay the additional tax.

 

The year-end Tax Reconciliation and what to expect

 

SARS will assess whether you’ve paid enough tax at the end of the tax year. If your income varies significantly from month to month, a tax directive might result in you underpaying your taxes. For instance, if Sam’s large commission at the end of the year pushes his total income into a higher tax bracket, the reconciliation will require him to pay the difference. This could mean a hefty bill if you haven’t set aside funds to cover it.

 

Alternatives to using a Tax Directive

 

Instead of relying on a tax directive, some individuals may find it more effective to calculate their tax obligations monthly. This approach adjusts your tax payments according to your actual income for that month, reducing the risk of underpayment. This method ensures that by the end of the year, you have paid the correct amount of tax, potentially avoiding a large reconciliation payment.

 

What you should know about provisional tax and penalties

 

Provisional tax is another option for managing your tax obligations, but it’s essential to understand how it works. Businesses typically use provisional tax, but individuals with irregular income can also benefit. The key is to avoid underpaying by more than 10% of your total tax liability, which will result in penalties and interest charges. The second provisional tax payment, due at the end of February, is particularly critical, as underpayments can attract penalties ranging from 5% to 10%.

 

Keep in mind

 

It is important to remember that Tax directives can be a valuable tool for managing your tax obligations, significantly if your income fluctuates. However, it’s essential to understand the implications, including the potential for a year-end tax bill and penalties. 

 

Carefully consider your income and consult with one of our tax professionals to determine the best approach for your specific situation and avoid the pitfalls of underpayment.

 

Contact Equate Group for expert advice on:

 

0860 EQUATE (378283)

info@equategroup.co.za

advisory@equategroup.co.za

payroll@equategroup.co.za