Shareholder employees usually pay themselves in 2 ways; drawings which is offset by a shareholder salary at annual accounting time or wages through the company payroll. If you want to understand which is better, take a look at this article.
The hassle of provisional tax can sometimes encourage a shareholder employee to add themselves to the company payroll, paying their tax in regular amounts through the PAYE returns.
There is potential to run into difficulty in this situation, especially when the shareholder has taken wages less than their usual salary and mixed this with additional drawings.
If the shareholder employee is being paid more than 66% of what they would normally receive as income through the payroll, they are limited to how tax can be paid on the remaining profit. Once this has happened for 1 year, you are then locked in to the same treatment for 3 years.
For example;
Bob’s building company Bob the Builder Limited usually has $70,000 profit per year. Bob is allocated a shareholder salary of $70,000 and pays provisional tax.
Bob takes on an employee in his third year of trading, still expects $70,000 profit and decides to add himself to the weekly payroll and pay himself $50,000 per year through PAYE. Bob takes additional drawings of $12,000 throughout the year.
There is now $20,000 profit left in the company which tax has not been paid on and Bob has an overdrawn current account of $12,000.
Bob pays company tax rates on the remaining $20,000 and also tax on the interest on his overdrawn current account.
The tax impact on this comes by being locked into this treatment for 3 years, where the interest on Bob’s overdrawn current account adds up very quickly. It also depends on when we prepare Bob’s accounts, and when we pick up that he has started paying himself wages.
Ideally, the aim is to either pay yourself the maximum wage possible at a fair market rate through the payroll or take drawings throughout the year and pay provisional tax on the shareholder salary, declared at annual accounts time.
As always, the most important thing is to speak with your accountant before making any changes. You can contact us if you would like to discuss this further.
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