How Income Tax Works in Australia (2025–26)
Published by SWIFT ACCOUNTANTS PTY LTD · Last reviewed · ATO 2025-26 rates
Australia uses a progressive income tax system — the more you earn, the higher the rate you pay on the portion of income above each threshold. This guide explains exactly how the system works, what the 2025–26 tax brackets are, how your employer withholds tax, and how to calculate your own estimated tax liability.
What Is a Progressive Tax System?
A progressive tax system means that higher income earners pay a higher percentage of their income in tax. But critically, the higher rate only applies to the slice of income above each threshold — not to all of your income. This is the concept of the marginal tax rate.
Think of it like filling buckets: the first bucket (up to $18,200) is taxed at 0%. Once it is full, income spills into the next bucket (up to $45,000), which is taxed at 16%. When that overflows, the next bucket (up to $135,000) is taxed at 30%, and so on.
This means no matter how high your income goes, the tax you pay on the first $18,200 is always zero — only your earnings above each threshold are taxed at the higher rate. The practical result is that your effective tax rate (the percentage of total income you actually pay in tax) is always lower than your marginal rate.
2025–26 Australian Income Tax Brackets
These are the tax rates that apply to Australian resident individuals for the 2025–26 financial year (1 July 2025 to 30 June 2026). The same rates applied in 2024–25 following the Stage 3 tax cuts.
| Taxable Income | Marginal Rate |
|---|---|
| $0 – $18,200 | 0% |
| $18,201 – $45,000 | 16% |
| $45,001 – $135,000 | 30% |
| $135,001 – $190,000 | 37% |
| $190,001+ | 45% |
Note: The above rates are for Australian residents only. Non-residents pay a flat 32.5% on the first $135,000 of income (no tax-free threshold), plus higher rates above that.
Example: Tax on an $85,000 Salary
Here is how income tax is calculated on a gross annual salary of $85,000 for 2025–26:
* Effective tax rate: 21.2%. Marginal rate: 30%. This excludes HECS/HELP, private health insurance adjustments, and any work-related deductions.
How PAYG Withholding Works
Most employed Australians never pay tax directly to the ATO themselves. Instead, their employer withholds an estimated amount of income tax from each pay and sends it to the ATO. This is called the Pay As You Go (PAYG) withholding system.
When you start a job, you complete a Tax File Number (TFN) declaration form that tells your employer whether you want to claim the tax-free threshold. If you only have one employer, you should claim the threshold — this means your employer withholds less tax from each pay because the first $18,200 is treated as tax-free.
At the end of the financial year (30 June), you lodge an income tax return with the ATO. The ATO calculates your actual tax liability based on your total taxable income, then compares it to what was withheld. If more was withheld than you owe, you receive a tax refund. If less was withheld, you have a tax debt to pay.
What Makes Up Your Taxable Income?
Your taxable income is not necessarily the same as your gross salary. It is calculated as:
Assessable income includes your salary and wages, freelance or business income, rental income, interest and dividends, capital gains, and some government payments.
Allowable deductions reduce your taxable income and include work-related expenses (tools, uniforms, travel, professional development), investment expenses, and contributions to certain schemes. Deductions directly reduce the income on which your tax is calculated — so a $1,000 deduction saves you $300 in tax if your marginal rate is 30%.
The ATO allows you to claim deductions for expenses you incur in earning your income, but you must keep receipts and records. Deductions are claimed in your annual tax return.
Tax Offsets: How They Differ From Deductions
A tax offset (also called a tax rebate) directly reduces the amount of tax payable — not just your taxable income. This makes them more powerful than deductions of the same dollar amount.
The most important offset for most Australians is the Low Income Tax Offset (LITO). For 2025–26, the maximum LITO is $700 for taxable incomes up to $37,500. It then phases out gradually, disappearing entirely at $66,667. The LITO is applied automatically by the ATO — you do not need to claim it separately.
For very low earners under $21,885, there is also the Low and Middle Income Tax Offset (LAMITO)which was a temporary offset that ended in 2021–22. It no longer applies.