You have options! Drawings, salary, shareholder salary, dividends - the list goes on. Every business is different, and different variables mean there’s no one size fits all. Whether you’d prefer to take drawings from your business or jump straight to a salary, it’s important to get a clear understanding of what all that actually means.
There’s a lot to consider, and it can be confusing trying to navigate the world of drawings vs salary in New Zealand. 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. 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.
Let’s start with the basics. What are drawings? 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 Drawings are simply money you have taken (withdrawn) from the company bank account for your own personal use.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 business, this cash goes straight into your pocket. The only downside is that you will be personally responsible for tax, aka, you need to be on top of your money management! No tax is deducted from drawings, so it’s recommended you set aside a little extra cash to cover any personal income tax.
Depending on your income (or tax bracket), it’s a good idea to put aside a certain portion of any drawings taken from the business for tax, and do it consistently. That way, when the taxman comes calling, you’ll be 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. If you want more info on what you need to put away based on your income, as your small business accountants we’re here to help. Get in touch here.
Do note that if you’ve injected money into the business (we call this ‘funds introduced’) 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. This also goes the other way. If you withdraw funds that are in excess of what you had put into the business in the first place, the taxman will definitely be paying a visit! 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 taking drawings vs a 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.
If you’ve been taking out drawings and as a result, withdrawn more funds than you have contributed as a shareholder, you will have what accountants call an ‘overdrawn current account’. In this case, your accountant will likely reclassify these drawings as a ‘shareholder salary’ (when your end of year accounts are done) and these funds will be taxed accordingly at your personal tax rate.
Any company profits can be directed to shareholders and may also be declared as a ‘shareholder salary.’ Again, the funds would be taxed at your personal tax rate rather than being kept in the company and taxed at 28%.
Now we come to the easier option for those wanting to avoid the hassle of paying their own tax at the end of the financial year. Getting paid a regular PAYE salary is the best direction 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. Effectively, you’re employed by your own company, which means that tax is deducted 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.
However, if you are a sole trader, unfortunately this isn’t an option for you. You can’t become an ‘employee’ of your own business unless you have a registered company.
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 when compared to large corporations. There’s a few things to consider when paying dividends, especially when it comes to tax.
Let’s talk about 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%. However, with the top tax rate in NZ at 39%, dividends that push a shareholders taxable income over $180,000 will now result in the shareholder having to pay an additional 6% tax.
In short, it all comes down to your type of business, your structure and what you want to prioritise. If your goal is to avoid having to set 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 might be for you.
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. As your small business accountants we’re here to help, and we’d be more than happy to sit down and have a catch up about your small business and what your best foot forward might be.
So go on, pop a time in the diary for a free non-obligatory chat, and we can catch up right from the comfort of your couch.