Should I pay myself PAYE wages or take drawings is a common question we get asked as accountants, and there are pros and cons to each. In this article we delve into those pros and cons and our preference as accountants from a tax perspective.
It should be noted that sole traders cannot pay themselves a PAYE wage so must take drawings.
PAYE wages
Pros
No surprises at year end. Tax is paid on a regular basis so there is no year end tax bill, assuming no further profits are paid to yourself from the company/partnership/trust. If there is further profit paid, the year end tax bill will be a lot smaller
Cashflow management is easier as smaller, more regular tax payments
ACC compensation claims can be easier as your income is able to be proved easily. However, we always advise clients be on CoverPlus Extra if they are taking drawings which negates this issue
If doing kiwisaver, contributions are paid on a regular basis therefore avoids having to remember to pay the $1043 annual contribution to get the Government contribution
Cons
More admin involved with filing PAYE returns. If you already have existing staff then this extra admin is minimal, however if you are the only staff member it creates a lot more work and requires payroll software (extra charges)
It removes the ability to tax plan at year end for the accountant. This is a big con because if the company/partnership/trust incurs losses while you are paid a PAYE wage, these losses cannot be offset against your personal income therefore you end up paying more tax
You need to sign an employment agreement with the company/partnership/trust
Once you opt in for PAYE wages, you cannot chop and change depending on your financial situation. You are committed for the entire financial year
Drawings
The business owner takes drawings during the year which is recorded as a debit to the owners’ account in the business entity, and at year end a shareholder salary (company) or profit allocation (partnership) or beneficiary distribution (trusts) is allocated to offset these drawings by crediting the owners’ account.
Pros
Tax is paid at year end, or over 3 instalments if you are a provisional taxpayer, so tax is paid less often, and funds can be used as working capital rather than bank overdraft. This is a great option if you are very disciplined and can put money aside for these payments
It allows more freedom with end of year tax planning. PAYE wages are set and cannot be undone or changed depending on the business financial situation (as you have a signed employment agreement). A shareholder salary/partnership profit/beneficiary distribution can be varied to minimize the tax paid
Cons
You need to be disciplined, so if you are not good at saving or are tempted to use the money in the bank account you may not have the funds available when it comes time to pay the provisional tax.
Seasonal variability in cashflow can make it hard to budget for the provisional tax payments, especially if your accountant isn’t proactive with managing the tax payments if the business experiences a downturn
If you are not on ACC CoverPlus Extra and need to make a compensation claim, it is trickier and more time-consuming proving your earnings to ACC than if on PAYE wages
If operating a trading trust you will not be covered under ACC if taking drawings and receiving a beneficiary distribution. You need to pay yourself a PAYE wage to have ACC cover
Our preference
Because of the significant tax savings that can be incurred by structuring salaries and profit allocation based on year end financial results, our preference is to take drawings. If you aren’t disciplined with money management, an automatic payment for the net amount that would have been paid if on a PAYE wage can be set up to ensure you aren’t drawing too much. This ensures the tax amount on what would have been the PAYE wage is retained in the business account for provisional or end of year tax.
This allows the accountant to structure the profit allocation to minimize tax payments. Too often we see situations where the company incurs a loss while the shareholder has been paid a PAYE wage of $100,000+ therefore tax has been overpaid. This loss in the company cannot be used until the company eventually makes a profit.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
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