If you are new to business ownership, or an experienced owner but unsure how paying yourself works from an accounting perspective, read on to find out the different ways to pay yourself depending on your business structure. Do you take cash drawings from the business or pay yourself a PAYE wage? We also go into how personal drawings affect the end of year tax return.
Sole Traders
Sole traders cannot pay themselves a PAYE wage so must take drawings, and set aside money to pay taxes, student loan and kiwisaver from their profits.
The end of year tax return calculates the profit as all business income minus business expenses. Drawings are not a deductible business expense therefore the profits at the end of the year does not take into account any drawings taken from the profits.
There are two ways to cover your personal expenses, the easiest way is to work out the net amount you would be paid if on a PAYE wage and set up an automatic payment from the business bank account to the personal bank account and live off this without using the business bank account for personal expenses.
The second way is to ask your accountant your average income tax rate as a percentage and set aside this amount for each sales income received to cover your taxes. If GST registered, you will need to add on 13% to the income tax percentage. This will ensure you have enough money set aside to cover taxes, and the remaining funds are to cover bills and personal expenses.
Partnerships
Partnerships are similar to sole traders in that usually drawings are taken from business profits rather than paying a PAYE wage. However, partners of a partnership can pay themselves a PAYE wage if there is a written employment agreement. This is then claimed as a deductible expense for the partnership in the tax return, with the net profit after paying the wage split between the partners.
Companies
Companies have a lot more flexibility and can pay either a PAYE wage or take drawings. Careful consideration needs to be given to taking drawings as the shareholder current account can become overdrawn, which creates tax issues (see this article Taking Drawings from the Company Bank Account).
Drawings are recorded in the shareholder current account as a loan. At the end of the tax year, the company calculates a 'paper' salary for the shareholders from the company profits. This is applied to the current account against drawings. The shareholder must pay income tax on the shareholders salary declared in their iIndividual income tax return.
If paying a PAYE wage, the company can claim this salary as a deductible expense in its end-of-year return. Same as a partnership, there must be a written employment agreement to pay a PAYE wage.
Trusts
We don’t often see trading trusts due to the risk involved for trustees, however trusts are able to pay a working beneficiary a PAYE wage, or the beneficiary can take drawings and this is offset at the end of the year by a beneficiary distribution from the trust. Ideally, PAYE wages would be paid as the person is covered for ACC as beneficiary distributions are not levied by ACC.
What's my best option?
No matter what business structure you operate, we recommend working out what your weekly/fortnightly/monthly living costs are then setting up an automatic payment from the business bank account to your personal bank account and using this to cover personal expenses. Ideally you would set a conservative amount so if anything goes wrong and you need to take some money from the business bank account, there is a buffer to draw on. This gives your accountant the ability to structure the profits paid to you in the most tax efficient way.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
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