How Australia taxes income
Australia uses a progressive tax system. Income is divided into bands, and each band is taxed at a set rate. The key point is that each rate only applies to the portion of your income within that band, not to your entire income.
This means a pay rise can never leave you worse off after tax. If higher earnings push some income into a higher bracket, only the amount above the threshold is taxed at the higher rate. Everything below it is unaffected.
The tax brackets for FY2025–26
The following rates apply to Australian residents for the 2025–26 financial year, following the Stage 3 tax changes that took effect on 1 July 2024:
- $0 to $18,200: 0% — tax-free threshold
- $18,201 to $45,000: 16 cents per dollar above $18,200
- $45,001 to $135,000: 30 cents per dollar above $45,000
- $135,001 to $190,000: 37 cents per dollar above $135,000
- $190,001 and above: 45 cents per dollar above $190,000
On top of income tax, most residents pay a 2% Medicare Levy. The two are calculated separately but usually quoted together as a combined effective rate.
A worked example at $70,000
On a taxable income of $70,000, the income tax is calculated step by step:
- First $18,200 at 0% = $0
- Next $26,800 (from $18,201 to $45,000) at 16% = $4,288
- Remaining $25,000 (from $45,001 to $70,000) at 30% = $7,500
Total income tax: $11,788. Adding the 2% Medicare Levy ($1,400) gives a combined bill of $13,188. On $70,000 income that is an effective rate of about 18.8%, even though the marginal rate (the rate on the top dollar) is 30%.
The tax-free threshold
Australian residents can earn up to $18,200 per year before paying any income tax. You claim this by ticking the relevant box on your tax file number declaration when starting a new job. You should only claim it from one employer at a time.
Foreign residents do not receive the tax-free threshold. They pay 30% from the first dollar of Australian-sourced income.
The Low Income Tax Offset (LITO)
LITO reduces the amount of tax owed by lower-income earners. It is applied automatically by the ATO when you lodge your tax return.
- Up to $37,500: full offset of $700
- $37,501 to $45,000: reduces by 5 cents per dollar (from $700 down to $325)
- $45,001 to $66,667: reduces by 1.5 cents per dollar (from $325 down to $0)
- Above $66,667: no offset applies
LITO is a tax offset (a direct reduction in the tax owed), not a deduction that reduces taxable income. It cannot reduce your tax liability below zero.
Marginal rate vs effective rate
Your marginal tax rate is the rate applied to the next dollar you earn. Your effective tax rate is the total tax paid divided by your total income, and it is almost always lower than the marginal rate.
The example above shows this clearly. On $70,000, the marginal rate is 30%, but the effective rate (including Medicare Levy) is about 18.8%. The lower rates applying to the first portions of income pull the average down significantly.
When someone says they are "in the 30% bracket," they mean their top dollar is taxed at 30%, not that they pay 30% on everything they earn.
What the Stage 3 tax cuts changed
The Stage 3 tax cuts took effect on 1 July 2024. The key changes were:
- The rate on the $18,201 to $45,000 band dropped from 19% to 16%
- The rate on the second bracket dropped from 32.5% to 30%
- The upper boundary of the 30% bracket rose from $120,000 to $135,000
- The 37%/45% boundary rose from $180,000 to $190,000
The net effect was a broad tax reduction for most earners, particularly those earning between $45,000 and $135,000.
Common misconceptions
"A pay rise could leave me worse off after tax"
This cannot happen in Australia's progressive system. Higher rates only apply to the income above the bracket threshold. Everything below is always taxed at the same rate regardless of what you earn above it.
"The top tax rate is 45%"
The top income tax rate is 45%, but the 2% Medicare Levy brings the combined top marginal rate to 47% for most high earners. Some also pay the Medicare Levy Surcharge on top of this if they earn above $93,000 and do not hold private hospital cover.
"I should avoid going over a bracket threshold"
There is no threshold worth avoiding. Higher rates only apply to the portion of income above the boundary. Earning $135,001 does not mean your entire income is suddenly taxed at 37% — only that one extra dollar crosses into the 37% band.
Frequently asked questions
How is tax calculated if I have multiple income sources?
All assessable income is combined. Wages, freelance income, dividends, and rental income are all added together to determine your total taxable income. The brackets then apply to the total, not to each source separately.
What is the difference between gross income and taxable income?
Gross income is your total earnings before any deductions. Taxable income is what remains after allowable deductions, including work-related expenses, salary sacrifice super contributions, and certain investment costs. Income tax is calculated on taxable income, not gross income.
Does my employer's SGC contribution reduce my tax?
No. Your employer's compulsory super contributions are paid separately on top of your salary and do not reduce your taxable income. However, voluntary salary sacrifice into super does reduce taxable income, which is the core tax benefit of that strategy.
How does the ATO know if I've paid the right amount?
Employers withhold tax through the PAYG system based on estimated annual earnings. When you lodge your tax return, the ATO reconciles your actual annual income and tax owed against what was withheld. Any overpayment comes back as a refund; any shortfall is payable.
Calculate your exact income tax, Medicare Levy, and take-home pay with the Income Tax Calculator. To see how salary sacrifice into super reduces your taxable income, try the Salary Sacrifice Calculator. For detail on the Medicare Levy and Surcharge, see Medicare Levy and Medicare Levy Surcharge Explained.