The business is up and running, you’ve got revenue trickling in and everything is going smoothly. But the end of the month is approaching and you have bills to pay. So how do you pay yourself? Things can get a little tricky if you decide against a salary, and you’ll face issues to do with tax, red tape and general semantics.
Getting paid as a small business owner comes in two forms: drawings and salary. It’s up to you to decide how you want to be paid.
Drawings Version One
The first way to pay yourself is to take money out of your profits as drawings. In Australia, this strategy is viewed as the shareholder taking a loan against the company and results in the ‘loan’ being treated as unfranked dividends. The shareholder pays tax on the amounts withdrawn at their applicable tax rate. Find out more about unfranked dividends on the ATO’s website.
Drawing up a formal loan agreement will help you avoid this pesky unfranked dividend situation, but you’ll have to pay interest back to your company and you’ll still pay tax on the cash – just over a longer period.
Drawings Version Two
Alternatively, you can take money out as drawings in the form of shareholder dividends, which means you’ll need to declare the dividend as income and pay tax on the gross value of the dividend at its tax bracket. A franking credit can also decrease the tax payable on dividends by 30%.
However, extra tax may be payable on benefits, such as the Medicare levy, depending on which marginal tax rate the owner is paying. In the event the owner ends up paying an income tax bill (instead of having their tax paid through the company), they have to pay PAYG instalments tax. Essentially, things start to get very complicated tax-wise, and you’ll need a specialist by your side to see you through these types of payments.
Taking a traditional salary makes life much easier from a budgeting and tax perspective. You pay yourself much like anyone else who works for your business would get paid, plus you don’t have the overly complex tax implications of drawings.
But what should your salary be? Well, it really depends on your capital – but a good rule of thumb is to take your market value (what you’d get from another employer per annum) divide it by 12, adjust the result for inflation and then include that in your monthly budgets.
Salary versus Drawings
Say you’ve got a solid grasp on the tax implications and complexities of using drawings as a wage and you’re ready to take the plunge – let’s give you some food for thought.
Money you take out of the company is money you can’t use to invest in the company, and money you keep in the company isn’t as heavily taxed, meaning it’s more valuable to you. The more money you invest in your business, the more likely it is to grow, and the more it grows, the more you can pay yourself down the track.
Further, a salary is a built-in cost that you can monitor against the performance of the company. You’ll be taking your salary into account when doing business, aiming to cover costs and turn a profit.
Whichever way you decide to go, paying yourself a salary could create a better long-term outlook, particularly if you use profits to invest in the business rather than yourself. Consult a professional financial advisor to help keep your business finance in check and to get advice about your own salary.