Clients often ask which is the best way to pay themselves from their company – wages or drawings? Here is an explanation of the differences.
Wages
If you decide to set yourself up as an employee of your company you will pay yourself a wage, deduct PAYE tax (like a normal job) pay yourself the net pay and pass on the PAYE tax to Inland Revenue each month. Wages are a tax deductible cost and reduce the profit of your business because tax is being paid on it as you go.
Also if you are in KiwiSaver you will contribute out of your wages but your company will also contribute to your fund (currently 3%) and this is claimable as a business expense in the company’s books.
Wages make it easier to get support from ACC if an accident occurs or when looking to secure lending as they show a record of regular earnings.
Please note this option isn’t available if you’re a soletrader as you can’t be an employee of yourself.
Drawings
Drawings are the most common way business owners pay themselves – especially small/start-up businesses. Drawings are withdrawals from the business for personal use. At the end of the year, a shareholder’s salary is worked out by the accountant. Note that a shareholder’s salary is not the same thing as an ordinary salary/wage as outlined above.
Drawings are reflected in the balance sheet rather than the profit and loss statement. Shareholders have a “current account” within the balance sheet, where drawings are allocated. This account operates similarly to a bank overdraft facility, with interest calculated once a year on the net drawings. At the end of the financial year, if the current account indicates that the shareholder owes money to the company after factoring in their shareholder salary, interest will be charged on the outstanding balance.
Taking drawings from your business is not a tax-deductible cost – you should be aware that you will need to put aside a bit of money for income tax as well. For example, say you take $800 per week drawings, you want to be saving at least an additional $200 per week for tax. Some people fall into the trap of living on a gross income rather than a net (after-tax) income. It’s easy to do when taxes are only worked out annually.
If you are in KiwiSaver you will have to pay this out of your own money and there are no contributions from your company into your fund.
Drawings offer the advantage of hindsight, allowing for potential tax savings for both the company and the shareholder. This approach can be especially beneficial for businesses with low or minimal profits. However, managing drawings can be more complex compared to handling salaries so it’s important to seek guidance from your accountant.
Conclusion
Overall the amount of tax that you pay will be the same in either scenario – but most businesses prefer to go down the wages path once their business is established and they have regular cashflow. When you are just starting out drawings are usually used because you don’t quite have that steady income yet to pay yourself a wage.
If you would like advice which is best for your situation please get in touch
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