Single Touch Payroll Phase 2 has been mandatory for Australian employers since 1 January 2022, but it's still where the most common payroll-reporting errors land. The core change from Phase 1 to Phase 2 is disaggregation — what used to be reported as "gross wages" now has to be split out into income types, tax treatments, allowance categories and cessation reasons. The ATO uses this richer data to pre-fill employee tax returns, feed Services Australia in real time, and (from 1 July 2026) enforce Payday Super contribution timing. Getting it wrong creates compounding problems — wrong tax treatment codes flow through to employee assessments, wrong allowance categories misclassify deductibility, missed finalisation declarations leave income statements stuck in "Not Tax Ready".
What changed from Phase 1 to Phase 2
Phase 1 reported gross wages, PAYG withholding and a few aggregated fields per pay event. Phase 2 expanded that into six categories that have to be reported separately:
- Income type + country code — separates salary/wages, working holiday maker income, foreign employment income, etc.
- Disaggregation of gross — gross now split into salary & wages, allowances, overtime, bonuses + commissions, directors' fees, paid leave, lump sums (A/B/D/E/W)
- Tax treatment code — a 6-character code capturing tax-free threshold, study/training loans, residency, Medicare exemption
- Employment basis — full-time, part-time, casual, labour-hire, non-employee, voluntary worker
- Cessation reason — when terminating, why (resignation, redundancy, dismissal, contract end, deceased, transfer, etc.)
- Allowance category — each allowance reported under one of 6 standard categories or "other"
These six categories drive everything downstream — pre-fill data in employee returns, Centrelink income reporting, tax-treatment validation. If they're wrong, downstream systems get wrong inputs.
Disaggregation of gross — what to separate
Under Phase 2, "gross wages" gets unpacked into specific component types so the ATO knows what each component is for tax-treatment purposes:
- Gross salary & wages — ordinary salary or wages including ordinary hours and standard time-and-a-half
- Overtime — paid for hours worked beyond ordinary, separately reportable
- Bonuses + commissions — performance bonuses, sales commissions, retention payments
- Allowances — itemised by category (see below)
- Directors' fees — distinct from salary; different tax-treatment rules
- Paid leave — annual leave, personal/sick leave, long-service leave, paid parental leave (each with sub-codes)
- Lump sum payments — A (long-service leave on termination), B (redundancy), D (genuine redundancy under cap), E (back pay), W (return-to-work payment)
- Salary sacrifice — superannuation, other fringe benefits, etc., reported separately so OTE can be correctly calculated
Tax treatment codes
The 6-character tax treatment code combines several individual employee circumstances into one composite. Each character represents:
- Char 1 — Regular (R), Actor (A), Horticulturist (H), Seniors and pensioners (S), Working holiday maker (W), Foreign resident (F), No TFN (N), Death beneficiary (D), Voluntary agreement (V)
- Char 2 — Tax-free threshold claimed (T) or not (N)
- Char 3 — Study/training loan obligation (S) or not (X)
- Char 4 — Medicare levy variation (e.g. half exemption, full exemption)
- Char 5 — Medicare levy surcharge variation
- Char 6 — Reserved / spare
For most regular Australian employees with the tax-free threshold and a HELP debt, the code is "RTSXXX". Get the wrong code and the employee's PAYG withholding is wrong every pay run — the system over- or under-withholds and the employee gets a refund or owes money at year-end.
Allowance categories — get them right
Eight standard category codes plus "other" — each allowance you pay has to map to one:
- Car (CD) — cents-per-km car allowance under the ATO threshold (88¢/km × business km)
- Award transport (AD) — award-prescribed transport allowances
- Laundry (LD) — washing/cleaning of work uniforms or protective clothing
- Overtime meals (MD) — overtime meal allowances paid under an industrial agreement
- Travel (RD) — overnight travel allowances when away from home for work
- Tools (TD) — allowance for use or supply of tools and equipment
- Tasks (KN) — task-based allowances (e.g. dirty work, height work)
- Qualifications (QN) — allowance for holding a qualification or certificate
- Other (OD) — anything that doesn't fit a specific category, with a free-text description
The ATO uses the category to determine whether the allowance is exempt from withholding (cents-per-km up to the threshold) or whether it's assessable to the employee with deduction-test logic applied. Misclassifying a meal allowance as "other" means the employee's pre-fill won't flag the deductibility correctly.
Cessation reasons
When you terminate an employee, Phase 2 requires a cessation reason. Seven standard codes:
- V — Voluntary cessation (resignation)
- I — Ill health
- D — Deceased
- R — Redundancy (genuine)
- F — Dismissal
- C — Contract cessation
- T — Transfer
Cessation reason flows through to Centrelink in real time. A wrong code (e.g. coding a redundancy as a resignation) can affect the ex-employee's Centrelink waiting periods and benefit eligibility — they can't fix it on their end without the employer correcting the STP record.
The end-of-year finalisation
STP replaced the old payment-summary regime. After the financial year ends, you finalise each employee's STP record — confirming that all reported amounts are correct and the year is closed. Once finalised, the employee's income statement in their myGov inbox marks "Tax Ready" and they (or their tax agent) can lodge.
Deadlines: 14 July for employers with 20 or more employees; 31 July for small employers (under 20). Finalising late delays your employees lodging their returns. Most payroll software flags this — check your STP dashboard mid-July.
For FY26 the same deadlines apply: 14 July 2026 (large) / 31 July 2026 (small). For FY27 (from 1 July 2026) the same finalisation regime continues alongside the new Payday Super cadence; see our Payday Super employer guide for how the two interact.
Common mistakes employers make
- Reporting allowances as part of gross wages without splitting them into the 6 categories — feeds wrong pre-fill into employee returns
- Wrong tax treatment code — particularly missing study/training loan obligations (employee under-withholds, owes ATO at year-end)
- Forgetting to flag salary-sacrifice components separately — affects OTE calculation, Super Guarantee, and pre-fill
- Treating a casual employee as full-time on the employment-basis flag — affects various downstream entitlements
- Missing the finalisation deadline (14 / 31 July) — leaves employees stuck on "Not Tax Ready" income statements
- Filing under the wrong cessation reason — affects Centrelink waiting periods for ex-employee
- Reporting overtime as part of ordinary salary — distorts OTE for Super Guarantee calculation
- Not updating tax treatment code when an employee's circumstances change (HELP debt added, residency change) — withholding mismatch grows over time
Talk to us
For most small employers, STP Phase 2 is set up correctly inside Xero, MYOB, QuickBooks etc. — the configuration was done at Phase 2 transition in 2022 and most things work. But the categories aren't self-correcting: a payroll-software change, a new allowance type, a new employee with an unusual tax circumstance — any of those can introduce a quiet misclassification that compounds. Annual STP reconciliation as part of EOFY is good practice, particularly heading into Payday Super on 1 July 2026 where the data quality matters more than ever.
Sources
STP Phase 2 employer reporting: ATO — STP Phase 2 for employers.
Disaggregation and reporting categories: ATO — STP Phase 2 employer reporting guidelines.
STP finalisation: ATO — Finalising your STP data.
