Taxes don't have to be complicated – especially in Japan
No, really. We promise. There's a way to plan your tax obligations that won't leave your head spinning, and you'll have a sense of what should be coming off your pay check each month. The good news is that Japan, like most other developed countries, has a progressive income tax system, so you pay more tax the more you make.
Oh, wait. That's not good news like, "hey a puppy!" But it's pretty good news because at least it's standard an in line with the rest of the world.
Let's see how much income taxes in Japan are with the progressive tax system, and how it affects you.
Japanese Tax Payer Personas — Enter “Front-End Fiona” & “Freelance Fred”
In the game of taxes and insurance premiums, context is everything. As we will see, there are a lot of variables involved in how taxes and premiums are calculated depending on one’s employment status, level of income, place of residence, age, household structure, and so on. To anchor us to a consistent narrative, we've constructed two different “personas” or profiles of likely tax payer types. It’ll be a lot easier to conceptualize how the system works is we can tie everything back to how our two individual tax payers would go about calculating their yearly obligations.
NOTE: The subject of tax and insurance obligations pertaining to business owners in Japan is a more advanced level of this game, and arguably requires a base understanding of everything that will be covered in this initial series. We'll certainly provide a companion guide for all of you hot shot entrepreneurs out there, but we have to walk before we can run, and run before we can fly.
Meet Fiona, age 28. She was hired as a front-end engineer by a Tokyo-based international tech company specializing in SasS (Software as a Service) products relevant to the Japanese market. Her contract type is 契約社員 “keiyaku-sha-in”, a full time company worker with full benefits paid, working on a yearly basis. She makes ¥4,200,000 a year of gross income (before taxes and expenses) from this one source. She lives in Shibuya-ku, Tokyo, with her husband Freelance Fred.
Meet Fred, age 31. Fred moved to Japan with his wife Fiona, and began working at a dispatch company teaching English to pay the bills while he worked on building his side hustle — a small, but profitable freelance videography practice. For his initial job at the dispatch company (now his waning part-time), he was hired as 業務委託 “gyōmu itaku”. Under this contract type, none of his benefits are covered, and he has little to no guarantee of job security. In exchange, he gets to dictate his own schedule and negotiate his rates. He prefers it for the freedom it allows him. But, among other complications, he is required to file his own taxes, as well as enroll himself in the national social welfare programs that cover health insurance and pension.
While his income is neither static, nor predictable on a yearly basis, he makes roughly ¥2,800,000 before taxes. His side hustle has really begun to gain traction, and he will likely transition out of teaching to become fully self-employed. He lives in Shibuya-ku with his wife Front-End Fiona, and works from home most of the time. If his situation seems a bit more complex than Fiona’s, that’s because it is. But as long as he familiarizes himself with self-employment taxation procedures, he'll be fine!
The Annual Tax Cycle & Income Tax
Now that we have ourselves a nice pair of personas, let’s orient ourselves within the annual taxation cycle, which is actually really simple. It starts on January 1st, and caps out on December 31st, throughout which time we earn income. At the end of the year, we have the sum total of all the income we’ve made. For most of us in the same boat as Front-End Fiona, this comes from one source — wherever we are employed. For others like Freelance Fred, income streams from multiple sources. We're then charged a percentage of money by the government and its various organizations based on how high that number is. This is called:
Income Tax — 所得税 “Shotoku-zei”
This is the percentage of money that the government takes out of an individual’s income after a series of adjustments accounting for expenses, deductions, and so on (more on this to come). Income is the anchor by which almost all other tax rates are calculated — simple as that.
Income Adjustment Flow & Related Terms
Before we advance any further, there’s an invisible elephant in the room that needs to be addressed:
Every time we make a hypothetical calculation in this series on the fundamentals of taxes and insurance, we are using our personas’ gross incomes without making any adjustments. In the real world when we file our taxes, we take a whole lot into consideration and make many adjustments to our income for our own personal benefit. These adjustments take our expenses and deductions into account. Because that’s the stuff of a later update to this series, we’re going to leave it out of our calculations for now. But here’s an overview of the relative terms, and their hierarchical flow in the order by which they are applied to one's income:
1. Gross Income — 総所得 “Sō-Shotoku”
Our base income before any expenses, deductions, or taxes are factored in
2. Expenses — 経費 “Keihi”
These get taken out of our gross income before our taxes and insurance premiums are calculated. They must all practically be related to how you make your income, such as commute fare, and general business expenses. Claiming expenses is a formal process that requires records of any money spent. This is why freelancers and business owners must keep track of them by collecting receipts and keeping their own books, or hiring an accountant to do this.
3. Net Income (after expenses, before deductions and taxes) — 収入 “Shūnyu”
The money left over in the form of profit or post-expense wages after expenses are taken out.
4. Deductions — 所得控除 “Shotoku-kōjo”
Adjustments made to net income which take into account certain personal obligations which effect our personal finances, such as dependents, disabilities, and even insurance and pension premiums.
5. Taxable Income — 課税所得 “Kazei-shotoku”
The final number left after all expenses and deductions are applied to income, by which tax obligations are calculated
6. Net income after taxes (NIAT) — 手取り “Te-dori” OR 所得 “Shotoku”
... And that's it!
Generally, income is adjusted in this flow until taxable income is arrived at, calculated, and paid. This can be a complex process however, so in the interest of keeping things simple while we learn the basics, we’ll omit this process until we can properly feature it and consider it in later posts. From here on, until we address income adjustments and drastically lowering our taxable income (high fives), each of the individual taxes explained will be calculated based on a gross number, meaning one before any adjustments, isolated from any other calculations.
How Much Is Income Tax in Japan?
Much like the US and Canada, Japan uses a “progressive tax system”, also called “graduated tax”. The meaning of this can be seen in the names — to graduate or progress is to move up on a steady basis. This is exactly what tax rates, also referred to as “tax brackets”, do within this system. This means that the more money an individual makes, the more money they will have to forfeit on income tax. Tax rates steadily climb until they reach a ceiling and can't climb any higher, which in terms of Japan is at the 45% mark. The table below displays each tax bracket and its corresponding tax rate as of 2020:
Progressive Tax Brackets in Japan
Brackets of Taxable Income
Under 1,950,000 yen
Over 1,950,000 yen or under 3,300,000 yen
Over 3,300,000 yen or under 6,950,000 yen
Over 6,950,000 yen or under 9,000,000 yen
Over 9,000,000 yen or under 18,000,000 yen
Over 18,000,000 yen or under 40,000,000 yen
Over 40,000,000 yen
An (Un)Popular Opinion
At first glance, this seems pretty bleak, at least for those of you out there who are high earners. From one perspective, you could say that it discourages people from pushing themselves to innovate in order to earn high levels of income. Why would they, when they have to forfeit just under half of their earnings at the highest level? However, the way this system actually works is often misunderstood, leading to a lot of frustration and resentment.
In theory, it was designed to redistribute wealth by taking the burden off of low earners while putting money in their pockets, which they'd use to stimulate the economy through the purchase of goods. To do this, it taxes high earners who can practically afford it. This has led to some people calling it “the wealth tax”.
The system is polarizing, and there’s arguably valid points on both sides — those who support it, and those who refute it. We won’t take a hard stance in this post arguing either for or against the progressive tax system, but we will explain how it works. For better or worse, it’s the tax system we are required to live under here in Japan. Instead of railing against it, it’s best to fully understand it so we can do what we can to plan around it and make it work in our favor.
First and foremost, no matter how much income an individual makes, he or she will never totally exist within one tax bracket. These brackets do not tax the totality of one’s earnings. It may seem that way at first glance of the above graph, but if we do the math, the numbers aren’t even viable, let alone ethical. In other words, with the exception of those whose earnings don’t exceed the lowest 5% bracket, no earner is “assigned to” or “belongs to” one single bracket based on their earnings.
For example, our own Front-End Fiona’s annual gross income of ¥4,200,000 will NOT be taxed as a whole by the corresponding 20% bracket. Before we dive into how progressive tax is actually calculated, let’s run these outrageous numbers to see why this wouldn’t work.
How Tax Brackets Might SEEM to (But Definitely Don’t) Work
If income levels were assigned to and taxed on a sole tax bracket in their entirety, Fiona’s annual ¥4,200,000 tax liability (the amount of money she owes in taxes) would look like this:
¥4,200,000 x 20% = ¥840,000
¥840,000 / 12 months = ¥70,000
¥350,000 (monthly salary) - ¥70,000 (hypothetical withheld income tax) = ¥280,000
Wow. Just… wow. If this was the case, then the government would be taking a ¥70,000 cut from this poor girl’s hard earned monthly ¥350,000, leaving her with a mere ¥280,000. She would have to live on this — and we haven’t even gotten to insurance and residence taxes yet. Fortunately, this is NOT how it works.
How Tax Brackets in Japan ACTUALLY Work
The first step in calculating tax rates is actually favorable towards the taxpayer. We'll fully expand on this in a later follow-up post, but this step is claiming deductions. Deductions are different types of lifestyle obligations which are necessarily paid for by an individual’s yearly income. The government allows us to subtract a portion of them from our gross income before tax rates are calculated. This lowers the amount of taxable income we have, which lightens the financial burden of paying our taxes. The money left over AFTER deductions is what’s taxed.
The progressive tax example we'll provide using Fred's and Fiona’s income won’t necessarily reflect the real-world calculations once various deductions are factored in. In reality, their rates would be much LOWER than our examples, because they would claim deductions to lower their final tax obligations. We WILL include the basic deduction of ¥480,000 (rate as of 2020) that every tax payer is entitled to.
Fred’s progressive tax calculations are the simpler of the two. First, we have to subtract the basic deduction of ¥480,000 from his gross income:
¥2,800,000 - ¥480,000 (basic deduction) = ¥2,320,000
Now we have his net income: ¥2,320,000. So we take this, and we remove the first ¥1,950,000 of it — the first tax bracket.
¥2,320,000 - ¥1,950,000 = ¥370,000
So let’s set that ¥370,000 aside and save it for later. First, we have to go back and deal with the initial ¥1,950,000 of Fred’s net income. Simply, we multiply it by 5%, its corresponding rate on our tax bracket graph.
¥1,950,000 x 5% = ¥97,500
Ok, so ¥97,500 is what we owe on the first level of taxes. Now, let’s go back to the remaining untaxed ¥370,000 left after we knocked out the first bracket. Since we already exceeded the first 5% bracket that goes up to the first ¥1,950,000 of our net income, we have to graduate up (eh? see how that works?) to the next tax bracket of 10%. So we multiple the remaining ¥370,000 by 10%:
¥370,000 x 10% = ¥37,000
Now all of Fred’s taxable income has been taxed, so we add the outcome of both tax brackets together to get Fred’s final tax liability:
¥97,500 + ¥37,000 = ¥134,500
The same formula would apply to Front-end Fiona’s gross income of ¥4,200,000. As with Fred, we'll first deduct the initial ¥480,000 to arrive at her net income.
¥4,200,000 - ¥480,000 = ¥3,720,000
Now we’ll subtract the first ¥1,950,000 from ¥3,720,000, and since we know that 5% of ¥1,950,000 is ¥97,500, we can just set that aside.
¥3,720,000 - ¥1,950,000 (accounts for ¥97,500 of tax obligation) = ¥1,770,000
The proceeding tax bracket after we exceed ¥1,950,000 is ¥3,300,000 which corresponds to a 10% tax rate. Fiona’s remaining ¥1,770,000 doesn’t exceed the ceiling of ¥3,300,000, we simply multiply ¥1,770,000 by 10%:
¥1,770,000 x 10% = ¥177,000
Finally, since we aren’t left with any taxable income, we just add ¥177,000 to ¥97,500 to arrive at Fiona’s final tax obligation:
¥97,500 + ¥177,000 = ¥274,500
So that’s the gist of it! In reality, there are a number of different variables that need to be factored in which usually result in a lower amount of taxable income, but a more complex calculation process.
Withholding Tax Vs. Self-Filing
Withholding Tax — 源泉徴収 “Gen-sen Chōshū”
If you are employed by a company, regardless of contract type, you’ve probably noticed something a bit peculiar about your bank balance on payday — a small portion of your money never actually makes into your account. While most people probably have an idea of why this is, we though it might be a good idea to elaborate on the specifics.
When an employer pays wages to an employee, the employer is required by law to automatically deduct a certain portion of said wages, and pay it directly to the tax office on the employee’s behalf. Unlike a self-employed person, who's responsible for tracking, reporting, and paying taxes on their own earnings at the end of the fiscal year, the employee’s process is much more streamlined. In essence, they never even see the money that they owe on taxes, because it’s “deducted at source”, or taken straight from their monthly wage. This is called “withholding tax” or 源泉徴収 “gen-sen chōshū” in Japanese. Remember this word, because it’s going to be important later on!
However much money an employee is projected to make over the year determines the amount of money extracted from his or her paycheck every month. For example, if Front-End Fiona is projected to make ¥4,200,000 by the end of the year, then her gross monthly income of ¥350,000 has a portion deducted based on her projected tax rates. If she were to receive any bonuses, then these would be taxed as well.
A quick note: when negotiating a salary or discussing one, make sure to figure out what the 手取り “tedori” is. We mentioned this above in our brief description of the income adjustment flow if you need a refresher.
At the end of the calendar year, her employer will file an end-of-year tax adjustment called 年末調整 “nenmatsu chōsei”. This will determine whether the prediction on how much she would earn was accurate or not. If it turns out she made more than was predicted, she’ll be subject to a repayment, meaning she will owe more money. This will likely be deducted from her final paycheck of the year. If she made less, then she will be entitled to a refund, meaning the money she over payed will come back to her. If the prediction was accurate, then it’s a wash — she is neither required to pay more, nor will she get any money back. In most peoples’ fiscal year, this is the most likely outcome.
NOTE: The end-of-year tax adjustment 年末調整 will be covered more in depth in a later part of this financial literacy series.
A Misconception Regarding Withholding Tax Calculation
Contrary to popular belief, withholding taxes are NOT calculated based on the previous year’s income in any way. It makes sense that this would be held as popular belief, as residence taxes and insurance premiums to be paid in the current year are based on last year’s income. However, income tax is contained within the calendar year and the fiscal year in which any year’s income is made. It then serves as the basis from which residence tax and insurance premiums are calculated in the following year. Last year’s income does NOT, however, affect their withheld income during the current calendar year.
In other words, income withheld at source during 2020 has nothing to do with the income an individual made in 2019. Whatever an individual’s expected income is for the year of 2020 becomes the basis from which the withheld income is calculated every month.
Self-Filing for the Self-Employed — 確定申告 “Kakutei Shinkoku”
If you are self-employed, you probably don’t have a consistent source at which your income can be held. You probably receive your income directly from whichever source(es) you earn it from, and the amount likely shifts from month-to-month. One month you might make ¥300,000+, while during another month you may not even break the ¥200,000 barrier.
Freelance designers, for example, often have waves of business in the middle of the year, whereas there may only be a light trickle of work at the beginning and the end of the year. Small hospitality businesses, independent IT contractors, and all sorts of other garden variety small businesses may also fall within this category. These types are responsible for keeping track of their own expenses and deductible items, as well as their gross income from month-to-month.
As with the subject of the 年末調整 mentioned above, we will cover this on a much deeper level in our subsequent follow-up posts. However, here is the basic idea of income tax for the self-employed from Freelance Fred’s perspective:
Throughout the year as he earns income, Freelance Fred is responsible for keeping his own books on how much he makes, as well as how much he spends to make that income. There are a whole bunch of deductible items that can lower his overall taxable income. These items might include materials, travel fare to meet clients, and even money spent on amenities like food and drink during their meetings, etc. For this reason, it’s necessary for him to collect all of his invoices, receipts, contracts, etc.
At the end of the fiscal year, or 年度 “nendo” (covered in depth in the next post), between February 16th and March 15th of every year, he goes to the tax office (or uses an official online service) and reports his earnings, expenses, deductions, etc. to the government. His taxes are then calculated, and he receives his tax bills in the mail, similar to his residence tax and insurance premiums. This process is called the 確定申告 “kakutei shinkoku”, or tax declaration, and is absolutely required of anyone who does not work as an employee.
For those who make fairly consistent income as sole-proprietors or self-employed workers, there is a streamlined process that they can opt into much like the employee’s 源泉徴収 withholding tax. It’s called 予定納税 “yotei nōzei” or “scheduled tax payment”, and behaves more or less like withholding tax. Self-employed tax payers must apply for it before May 15th of the fiscal year, and must make at least ¥150,000 per year of taxable income. This is a good option for those who prefer to place their money in a designated holding account to simplify their final tax return, as well as their own personal budgeting.
Interested in how mandatory health insurance and pension payments come out of your paycheck in Japan? Read on!