Single Touch Payroll (STP) Phase 2 has been mandatory since January 2023, but compliance issues continue to surface. The ATO is increasing enforcement activity in 2026, sending warning letters to employers who haven’t yet updated their reporting to meet Phase 2 requirements.

If your payroll software is set to “STP Phase 2” but you haven’t reviewed what’s actually being reported, there’s a reasonable chance you’re not fully compliant. Phase 2 requires significantly more detailed information than Phase 1, and many businesses are still reporting at Phase 1 level without realising it.

What STP Phase 2 Added

STP Phase 1 (which started rolling out in 2018) required employers to report:

• Gross wages
• PAYG withholding
• Superannuation liability

Phase 2, which became mandatory for most employers by January 2023, adds:

Disaggregated Gross Wages

Instead of reporting a single “gross wages” figure, you must break it down into specific components:

• Ordinary time earnings
• Lump sum payments (termination, back payments)
• Overtime
• Bonuses and commissions
• Salary sacrifice amounts
• Directors’ fees
• Return-to-work payments

The ATO uses this disaggregated data to pre-fill income statements more accurately and to identify potential discrepancies in employee tax treatment.

Employment Types and Tax Treatment

You must report whether each employee is:

• Full-time
• Part-time
• Casual
• Labour hire
• Seasonal worker

And you must report the tax treatment category, which includes codes for:

• Regular employee
• Working holiday maker
• Foreign resident
• Seasonal worker program participant
• Other specific tax treatments

This is where many businesses get tripped up. If you’re reporting all employees as “regular” when some are actually casuals, or you’re not flagging working holiday makers correctly, your reports don’t comply with Phase 2.

Employment Conditions and Cessation Reasons

When an employee leaves, you must report the reason:

• Resignation
• Termination
• Redundancy
• End of contract
• Retirement
• Death

This affects how the ATO treats final payments and whether employment termination payments (ETPs) qualify for tax concessions.

Country Codes for Foreign Employees

If you employ foreign residents or people working temporarily in Australia, you must report their country of residence. This helps the ATO apply correct tax treatments and comply with international tax information exchange agreements.

Why Phase 2 Matters

The ATO’s goal with Phase 2 is to reduce errors in income tax returns, improve superannuation compliance tracking, and enable more targeted compliance activities. For employers, the benefit is supposed to be that employees receive more accurate pre-filled data in their tax returns, reducing queries and amendments.

The risk of non-compliance is that the ATO will identify discrepancies between what you report via STP and what they expect based on industry benchmarks, triggering audits or reviews. The ATO is increasingly using data analytics to flag anomalies—things like consistently high “allowances” relative to base pay, or patterns of under-reporting overtime.

Check Your Payroll Software Settings

Most payroll software (Xero, MYOB, QuickBooks, ADP, etc.) was updated to support STP Phase 2 by 2023. But software being “Phase 2 capable” doesn’t mean your specific setup is reporting correctly.

Log into your payroll system and check:

1. Payroll reporting settings: Is STP set to Phase 2 mode? Some systems default to Phase 1 unless explicitly switched.

2. Pay item mapping: Are your pay items (salary, overtime, bonuses, allowances, etc.) correctly mapped to STP Phase 2 categories? If all your pay items are mapped to “ordinary time earnings,” you’re not disaggregating properly.

3. Employee classifications: Are employees correctly marked as full-time, part-time, or casual? Is tax treatment coded correctly for working holiday makers, foreign residents, etc.?

4. Termination reporting: When you process final pays, does the system prompt you to select a cessation reason? If not, you might not be reporting terminations properly.

Most payroll software providers have Phase 2 compliance checklists and help documentation. If your software doesn’t clearly show how to configure Phase 2 reporting, contact their support team.

Common Compliance Gaps

From discussions with accountants and payroll managers, these are the most frequent Phase 2 issues:

Not disaggregating lump sum payments. Redundancy payouts, unused leave payments, and back payments need to be reported separately from regular wages. Many systems still lump these into “gross wages” unless specifically configured otherwise.

Incorrect employee classification. Casuals misclassified as part-time, or full-timers coded as casuals. This affects superannuation guarantee obligations and tax treatment.

Missing tax treatment codes. Working holiday makers not flagged correctly, meaning they’re being taxed at standard resident rates instead of the working holiday maker withholding rates. This creates a mismatch that the ATO will eventually pick up.

Salary sacrifice not reported separately. If employees salary sacrifice to super or fringe benefits, that amount needs to be reported as a separate data field, not just subtracted from gross wages.

Directors’ fees not itemised. Directors who are also employees need their director fees reported separately from salary. Many small businesses don’t distinguish this.

What Happens If You’re Not Compliant

The ATO’s enforcement approach has been relatively light during the Phase 2 transition period, but that’s changing. In 2026, they’re sending “please explain” letters to businesses with obvious reporting gaps.

If you receive a letter, respond promptly. Usually the ATO will give you an opportunity to correct your STP reporting going forward without penalties, provided you act quickly and demonstrate you’re working toward compliance.

Ignoring ATO correspondence or failing to fix issues can lead to:

• Penalties for failing to lodge STP reports correctly (up to $1,110 per report for medium businesses)
• Audits of payroll records and tax withholding
• Superannuation guarantee audits if there are discrepancies between STP reporting and super contributions

Employer Obligations Summary

To be fully STP Phase 2 compliant:

• Report pay events on or before each pay day (not at the end of the month)
• Disaggregate wages into the required categories
• Report correct employment type and tax treatment for each employee
• Report cessation reasons when employees leave
• Include country codes for foreign employees
• Report salary sacrifice separately
• Keep records that match your STP reports for five years

Getting Help

Talk to your payroll software provider first. They can usually walk you through Phase 2 configuration specific to your system. Most have free webinars or support documents.

Engage an accountant or bookkeeper if your payroll is complex (multiple award rates, overseas employees, labour hire, etc.). A few hours of professional setup can save significant compliance headaches.

Use the ATO’s STP Phase 2 guide. The ATO has published detailed technical specifications and a practical guide for employers. It’s dry reading but comprehensive.

The Bottom Line

STP Phase 2 isn’t new, but compliance still isn’t universal. If you haven’t specifically checked that your payroll system is correctly reporting the additional Phase 2 data fields, do it now. The ATO is moving from a “give people time to transition” approach to a “compliance is mandatory” approach, and getting caught out is avoidable with a few hours of configuration work.

Most payroll software makes Phase 2 compliance straightforward once you understand what’s required. The problem is that many business owners assume their system is handling it automatically, when in fact it requires manual setup and mapping.

Take an afternoon, review your payroll settings, and confirm you’re reporting at Phase 2 standard. It’s a boring task, but it’s infinitely less painful than dealing with an ATO audit.