Drawings or a PAYE wage?

Drawings or a PAYE wage? How should you pay yourself from your business?

When you're self-employed, a seemingly simple question is: how should I actually pay myself?

Should you simply take drawings from the business, or put yourself on the payroll and pay PAYE like an employee?

The answer depends largely on your business structure, along with your tax, cash flow and ACC circumstances.

First things first: what are drawings?

Drawings are simply money or other value you take from your business for personal use.

For a sole trader or partnership, this may be as simple as transferring money from the business account into your personal account.

A company is slightly different. Money taken personally by a shareholder will generally be recorded through their shareholder current account (still classed as drawings) – effectively the running loan account between the shareholder and the company.

Your current account increases through things such as capital introduced, a shareholder salary allocated at year-end, or a dividend declared by the company. It decreases through drawings, private expenses paid by the company and other private-use adjustments.

Monitoring this account is important. If you take more from the company than has been credited to you, your current account can become overdrawn. This can create tax consequences where the company is effectively providing an interest-free or low-interest loan to the shareholder.

Sole traders – keep it simple

For a sole trader, the answer is generally straightforward. You don't pay yourself a wage in the same way you would an employee – instead, you take drawings from the business.

Although drawings don't determine your taxable income, good discipline is important. A regular weekly or fortnightly drawing can be a useful way to manage both personal and business cash flow.

Your income tax is calculated on the taxable profit of the business, regardless of how much you draw.

If your residual income tax is more than $5,000, you will generally enter the provisional tax regime and make income tax payments during the following year. Otherwise, your income tax will generally be payable as terminal tax after year-end.

You can also make voluntary tax payments during the year if you prefer paying tax progressively rather than facing a larger bill later.

Partnerships and look-through companies

Paying a PAYE wage can become more useful with these structures.

For a partnership, a partner generally cannot simply be treated as an employee. However, a PAYE wage can be paid where there is a written contract of service agreed to by all partners.

For a look-through company, a working shareholder can also be paid a PAYE wage, subject to the usual requirements.

The main benefit is tax cash flow. PAYE is deducted and paid to Inland Revenue throughout the year, meaning some of your tax is already paid rather than being dealt with through larger income tax or provisional tax payments later.

There is also generally less downside if the PAYE wage proves to be too high relative to the year's profit. If a partnership or LTC makes a tax loss, that loss generally flows through to its owners, subject to the relevant tax rules and limitations. If too much PAYE has been paid, this may therefore result in an income tax refund to the owner.

What about an ordinary company?

For a standard company, there are a few more things to consider.

A regular PAYE salary can provide certainty over how much a working shareholder receives and can help prevent the shareholder current account becoming overdrawn.

However, you don't necessarily need to be on PAYE.

Many owner-operated companies instead allocate a shareholder salary at year-end based on the value of the services the shareholder has provided. This is credited to the shareholder's current account and forms taxable income to the shareholder.

The main advantage of PAYE is therefore often timing and cash flow. Tax is paid progressively throughout the year, reducing the risk of reaching year-end with a large personal tax liability or unexpected provisional tax payments.

There is, however, a risk in setting the PAYE wage too high.

If the company has a difficult year, a high PAYE salary could result in the company making a tax loss. Unlike a partnership or LTC, that loss generally remains in the company rather than flowing through to the shareholder.

The loss can generally be carried forward and used against future company profits, but this doesn't provide an immediate cash flow benefit through getting an income tax refund. You may therefore have paid PAYE personally while the tax benefit of the company's loss isn't realised until a future year.

For businesses with fluctuating profits, this is worth considering when setting the level of a PAYE salary.

Don't forget about ACC

The way you pay yourself can also affect your ACC position.

ACC CoverPlus Extra allows eligible self-employed people to agree on a level of cover rather than simply relying on their actual self-employed earnings. This can be useful where you want your cover to better reflect what would be required if you were unable to work, such as the cost of replacing your labour in the business.

Receiving your remuneration as a PAYE wage or salary can affect your eligibility for CoverPlus Extra, so your ACC position should also be considered before changing how you pay yourself.

So, drawings or PAYE?

There is no one correct answer. The best approach should be tailored to your individual circumstances and preferences, taking into account factors such as cash flow, ACC cover and your shareholder current account position.

Talk to your MBS Advisor about which option best suits you and your business.

‍

Liam Crean, Associate Director, MBS Advisors

‍