Wages or drawings: How should I take money out of my business?

As a business owner, should you pay yourself with wages or drawings? It’s a very common question we’re asked and, like most tax questions, the answer isn’t simple.

There are many different ways you can take cash from the business and generally these will fall into one of the following categories:

• Wages
• Directors Fees
• Contractor Fees
• Dividends
• Trust distributions
• Drawings
• Loans

From your perspective, the business is yours so it’s all your money right? If you run your business through a company or a trust, then no, technically it’s not all yours and there are different implications for each. You should understand how each is treated because if things go pear-shaped (for example, a liquidation) it can have some major implications to you, the business and your future.

 

How do I work out what to pay myself?

As a small to medium businesses owner you are probably working large hours and taking on many roles. For this work, you are entitled to draw a wage. If it wasn’t you doing the work then it would be someone else and the business would be paying them a wage. Often it can be difficult for a business owner to assess what is a commercial wage they should be paid. We can help you to determine this rate based on industry benchmarks and the business’s finances.

 

Is a wage the most tax effective way to take the money out?

Let’s look at an example of taking a wage versus a loan for $100,000:

If you take a wage, the implications are :

• PAYG withholding (wages tax) of $26,520
• Superannuation of $9,500
• Possibly need to pay payroll tax of $4,750
• This will result in you not getting $100,000 cash, but $73,480 due to the reduction from PAYG withholding.
• The business has to pay an additional amount of up to $14,250 (super and payroll tax).  How does this affect cashflow?

If you take a loan the implications are:

• The business does not get a tax deduction for the $100,000, unlike the wage.
• You get the full $100,000 initially, but few things are that simple. The ATO has rules around taking out money from a business. You can read more about that in our article on Division 7A loans.
• You have no income in your tax return which has implications if you want to obtain finance.
• Your business accounts show that you owe the business this money.

 

It all goes pear-shaped and you have a loan to the business

The business is going along well, and then something happens through no fault of your own ie the market you trade in stops, an employee sues the business, a customer sues the business and you end up in a scenario whereby you don’t have a choice and you have to liquidate.  In this situation, your accounts show that you owe money to the business and the liquidator could come after you personally to get the money repaid.

You need to understand how you are taking money out of the business and what the short and long term effects of this are.  It isn’t all about tax – there’s an impact if there is a crisis, if you separate or divorce, if you want to sell the business or succeed out of it.

 

Further help:

If you’re struggling to make sense of your numbers and need help with management accounting, contact our business advisors for further assistance.  You can reach us on (07) 3023 4800 or at mail@marshpartners.com.au.

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