Back pay sounds simple until you have to process one. Maybe an award increase was applied late, or a pay rise was backdated to earlier in the year. Either way, you’re now paying an employee money that belongs to past pay periods, and the usual tax tables don’t fit.
Here’s how to work out the withholding, what happens with super, and how to report it through STP.
Key takeaways
- Back pay is taxed under ATO Schedule 5, the tax table for back payments, commissions, bonuses and similar payments
- You’ll use Method A or Method B, and tax withheld under Method A is capped at 47% of the back payment
- Super rules follow the underlying payment. Back pay of ordinary earnings attracts SG, back pay of overtime doesn’t
- Back pay that accrued more than 12 months before the payment date is reported as Lump Sum E in STP, whatever the amount
- Under STP Phase 2 you report the financial years the back pay relates to, so you no longer need to give the employee a breakdown letter
What counts as back pay?
Back pay is any payment of salary or wages that should have been made in an earlier period. Common triggers include:
- Award or EBA rate increases applied late
- Underpayments picked up in a payroll review or remediation
- Missed allowances, penalties or loadings
- Pay rises backdated to an earlier effective date
- Back payments ordered under a settlement or Fair Work outcome
Because the money relates to more than one pay period, you can’t just add it to this week’s wages and run the standard tax table. That would tax the lump sum as if the employee earns it every week, and withhold far too much.
How is back pay taxed? Schedule 5 explained
The ATO’s Schedule 5 spreads the back payment across the year so the withholding lands close to what the employee would actually owe. It gives you two methods, and both are acceptable.
Method A works for any back payment, whichever financial year it relates to. It’s the simpler option. You apportion the back pay across the number of pay periods in a year (52 weekly, 26 fortnightly or 12 monthly), work out the extra withholding that average amount creates, and multiply it back out.
The steps:
- Work out the employee’s normal gross earnings for the current pay period, ignoring cents
- Use your regular tax table to find the withholding on that amount
- Divide the back payment by the number of pay periods in the year, ignoring cents
- Add the step 3 amount to the normal gross earnings
- Find the withholding on the combined amount
- Subtract step 2 from step 5
- Multiply the result by the number of pay periods in the year
- Multiply the back payment by 47%
- Withhold the lesser of steps 7 and 8
- Add the step 9 amount to the normal withholding from step 2 for the total this pay
The 47% cap at step 8 matches the top marginal rate of 45% plus the 2% Medicare levy. For most employees the step 7 figure is lower and the cap never comes into play. The same schedule and cap apply when you tax a bonus, so the mechanics here will look familiar if you’ve processed one recently.
Method B is more work but gets closer to the employee’s actual end-of-year tax. Use Method B(i) for back payments that relate to specific periods in the current financial year, and Method B(ii) for back payments relating to a prior financial year, or payments that don’t relate to a single defined period.
If your employee has a study or training support loan (HELP and similar), you also withhold a loan component from the back payment using the same method.
How to calculate tax on back pay: a worked example
Mia earns $1,150 a week and claims the tax-free threshold. An award rate correction means she’s owed $2,600 in back pay, covering several months of the current financial year. Her employer uses Method A.
- Normal gross earnings: $1,150. Withholding from the weekly tax table: $186
- Back pay apportioned across the year: $2,600 ÷ 52 = $50
- Combined amount: $1,150 + $50 = $1,200. Withholding on this: $202
- Difference: $202 − $186 = $16
- Multiplied back out: $16 × 52 = $832
- Cap check: $2,600 × 47% = $1,222. The $832 is lower, so that’s the withholding on the back pay
Mia’s total withholding for the pay is $186 + $832 = $1,018. Compare that with what happens if you skip Schedule 5 and just add $2,600 to one week’s pay: the tax table treats her like a very high earner for that week and withholds far more than she’ll owe.
Is back pay superable?
The super rules don’t change just because the payment is late. Look at what the back pay is actually for:
- Back pay of ordinary time earnings, like base wages, most allowances and casual loading, attracts SG
- Back pay of overtime doesn’t, because overtime isn’t ordinary time earnings
SG is calculated at the rate that applies when you make the payment, currently 12%, and under Payday Super the contribution needs to reach the employee’s fund within seven business days of payday like any other pay.
How to report back pay in STP (and when it becomes Lump Sum E)
This is where the rules have changed the most in recent years, and where older guidance will lead you astray.
How you report depends on when the back pay accrued:
- Accrued within the last 12 months. Report it in STP as the relevant payment type: gross, allowances or overtime, matching what the payment is for.
- Accrued more than 12 months before the payment date. Report it as Lump Sum E. There used to be a $1,200 threshold, but from 1 July 2025 it no longer applies. Any back payment that accrued more than 12 months ago is Lump Sum E, whatever the amount.
When you report Lump Sum E under STP Phase 2, you specify the financial year (or years) the payment relates to. That detail flows straight to the ATO and appears in the employee’s income statement, so you no longer need to write the employee a letter breaking the amount down by tax year. The ATO uses the breakdown so the employee can access the lump sum in arrears tax offset where it applies, rather than being taxed as if they earned it all in one year.
If the back pay spans the 12-month boundary, apportion it. The part that accrued within 12 months goes to gross (or allowances or overtime), and the part older than 12 months goes to Lump Sum E.
Get back pay right the first time
Back pay sits at the messy intersection of tax, super and STP reporting, and each piece has its own rules. Classify the payment wrong and you’ll either over-withhold from your employee or under-report to the ATO, and both create cleanup work later.
At Alltech, we manage payroll for 150+ businesses across Australia, including the back payments, remediations and award corrections that don’t fit neatly into a standard pay run. Get in touch to find out how outsourced payroll works and whether it’s right for your business.
Figures use the ATO’s weekly withholding formulas current at the time of writing. Rates and thresholds move, so check the current Schedule 5 and tax tables on the ATO website before processing.