Kai Daniel
November 22, 2021
Well, in the words of Pitbull, you got you got options. Drawings, salary, shareholders salary, dividends - the list goes on. Every business is different, and different variables mean there’s no one size fits all or best pick here. Whether you’d prefer to take drawings from your business or jump straight to a salary, it’s important to get a better understanding of what all that actually means, too.
There’s a lot to consider, and it can be confusing trying to navigate the wild world of drawings vs salary in NZ - and trust us, we’re accountants. If we say it’s confusing, it’s confusing. How much do shareholders get paid? Can shareholders take a salary from the business? What’s a director’s salary? It’s a lot, we know.
(Cue tacky segue) And it’s a lot we can help with. That’s why we’ve gone ahead and pulled together a quick guide to finding the right option to pay yourself as a small business owner. Let’s break down those options.
Alright, let’s start with the basics. What are drawings? Well, before you get ahead of yourself, drawings are not your salary or your profit. Drawings are simply money you have taken (withdrawn) from the company bank account for your own personal use.
If you own your own business, this cash goes straight into your pocket. The only downside is that you will be personally responsible for tax, aka, you better be on top of your money management game. No tax is deducted from drawings, so it’s recommended you set aside a little extra cash to cover any personal income tax. Nothing says efficient and effective like having to sort your own tax.
Depending on your income (or tax bracket), it’s a good idea to put aside a certain portion of your income for tax, and do it consistently. That way, when the taxman comes a-calling, you’ll have a neat little pocket of dosh all ready to cover your tax bill. For example, say you take out $4000 per month ($48k/year) in drawings and have no other personal income, you’d need to put away around 15% for tax. Ignore the pain, it needs to be done. To find more specific info on what you need to put away based on your income, check out this tax calculator. It’s very clever.
Do note that if you’ve injected money into the business and those funds have already been taxed, you may withdraw this amount and will not be required to pay tax on it. Otherwise you’d be taxed twice on the same funds - and no one’s paying twice for one piece of cake around here. This also goes the other way. If you withdraw funds that are in excess of what you’d put into the business in the first place, the taxman will definitely be paying a visit for those extra dollars. Watch your back. And unfortunately, drawings are not a business expense, so there’s no writing that off against your tax either.
If you’re wondering about the benefits of drawings vs shareholder salary in NZ, read on. A shareholder salary is a non-PAYE wage allocated to a working shareholder of a company at the end of the financial year. This is calculated and paid out once the financial accounts are completed and the company profit has been determined.
This is important because to declare a shareholder salary, the company needs to earn a profit to allow a shareholder salary to be paid. No profit, no salary. Because this is a non-PAYE payment, this dosh is subject to tax, which the shareholder is then responsible for paying. So again, get on top of your money management game, shareholders.
Ah, now we come to the easier option for those wanting to avoid the hassle of paying their own tax at the end of the year. Getting paid a regular PAYE salary is the best way to go if you don’t want to deal with paying tax in the future, because with this option, your tax is paid for you by your business on an as-you-go basis.
Another perk is that paying yourself through the payroll system also ensures that you receive a regular salary payment. Think guaranteed payments, baby. Effectively, you’re employed by your own company, which means that tax is deduced by your business before it gets to you, so whatever cash makes it to your pocket is yours to keep. No need to worry about paying personal tax, my friend.
However, for all your sole traders out there, unfortunately this isn’t an option for you. You can’t become an ‘employee’ of your own business unless you have a registered company, so that rules you out. Bummer.
Our final option: dividends. A dividend is a distribution of business profits by a company to its shareholders. This is less common in small businesses with just a few shareholders, especially compared to the big boys with large corporations. There’s a few things to consider when paying dividends, especially when it comes to tax. Buckle up.
Let’s talk tax increases. When a company declares a dividend, they are also required to attach 33% tax credits for the shareholders. However, with the standard company tax rate at 28%, this typically requires companies to pay an extra 5% to top up the tax credits to 33%. On the other hand, if those profits were kept in the company as opposed to distributed, the company would only be taxed 28%. If you’re still following, great work.
Shareholders income and tax brackets: In the past, the top individual tax rate was 33%. This meant that no additional tax had to be paid by the shareholder when they received their dividend, because the company had already covered that 33%. Makes sense. However, with the top tax rate in NZ lifting to 39%, dividends that push a shareholders taxable income over $180,000 will now result in the shareholder having to pay an additional 6% tax. Mo’ money, mo’ tax.
So. You’ve heard your Miranda rights. Now it’s time to pick your poison - but which option is right for you? In short, it all comes down to your type of business structure and what you want to prioritise. If your goal is to avoid setting aside money to pay your own tax at the end of the year, then a PAYE salary might be the way to go. If you’re on top of the money game and aren’t bothered by the extra admin, then a Shareholder salary or dividends may be the way to go.
As always, there are different variables that will dictate which is the best option for you, and if you’ve made it this far and still aren’t sure, never fear. We’re here to help, and we’d be more than happy to sit down and have a chinwag about your small business and what your best foot forward might be.
So go on, why not pop in for a coffee and a chat, or just drop us a line and we can chat right from the comfort of your couch. In fact, we’re sitting by the phone right now. Just waiting for your call. Hand on the receiver and all. Make our day?
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