Small business owners often ask us: “what is the best way to pay myself?”
To answer this question, we need to assess the factors and priorities that shape your particular circumstances.
If you are running a business under a company structure, a good strategy to ensure you are paying minimal tax (depending upon your personal circumstances) is to pay yourself a base salary that you receive on a consistent basis, re-invest the rest of it back into the business and if there is any surplus, to pay this out in the form of dividends. This gives you the flexibility of both getting additional recurring income for yourself, but also the ability to grow the business and make it profitable, so it can repay you in dividends.
In comparison, there are strict rules that need to be considered before you draw your money out a company structure, as a company is a separate legal entity.
You cannot draw money out of your company that exceeds any amounts you have previously loaned to it. In a circumstance where you are looking to do this, you may need to enter into a Division 7A loan agreement with the company in order to do this. Otherwise, any excess at the end of the financial year may be treated as an “unfranked” dividend, and may be assessable to you at your marginal tax rate.
If you are running your business as a sole trader, the rules are less stringent and you will be able to “draw” money out as you can afford*. Accordingly, any net profit from the business will be assessed at the end of the year based on your allowable deductions.
Pro tip: Setting up a different bank account to keep your business and personal funds separate will allow you to keep track of differing drawings for different purposes.
*It is important that monies drawn out are realistic and reflective of the business’ financial circumstances. Further, keep in mind that operating under a sole trader structure means that the exposure to liability will be against yourself personally.
If you are running your business under a trust, you will be able to “draw” the money out from the trust and treat it as a loan from the trust.
Accordingly at the end of the financial year once the profit is worked out and distribution of profits are made, this would be offset against any amounts “drawn” out.
Personal services income (PSI)
If you are the only person in your business, chances are PSI may apply to you. Under PSI rules, the ATO will examine your business structure, and may require you to attribute all net income earned to yourself directly.
For example, if you operate through a company and PSI rules apply, this would mean that you are unable to retain any profits in the company, as you would need to attribute all net income to yourself.
The ATO has a strict PSI test that you can use to work out if PSI applies to you.
Under PSI, there are also some deductions that are not allowed such as rent, mortgage interest, rates, land tax for a home that is a place of business or payments to a spouse for support work.
Scale of business or future plans
Depending on the stage of business you are at, there may be commercial considerations in deciding how to pay yourself.
For instance, if you are looking at purchasing a home in your own capacity, you may be required to show consistency of payments from your business and hence may wish to pay yourself a regular full-time salary to provide such evidence.
Alternatively, if you are a business looking to obtain financing or raising capital to grow your business, you may wish to reduce your income level to market value and leave surplus in your business so that it presents a better and more accurate picture to the financiers.
So, what's the best way to pay yourself?
As can be seen, there are pros and cons to the different ways of paying yourself.
The better question is: “what’s my main priority right now, and how would this tie in with my long-term goals?”
Working with the right adviser can assist you in unlocking this answer.
PAQ Group specialises in all things bookkeeping including GST, PAYG and other related taxes. We understand the struggles that small businesses have with cash flow and arranging investments.
We are confident that we will be able to assist you with any issues you may encounter in your business. We do this by providing up-to-date bookkeeping, regular catch-ups, and the steps you can take to optimise your business operations.
If you need any help with your business’ financial planning, please do not hesitate to contact us on our website.