I often get asked by small business owners about how they should be paying themselves and the advantages and disadvantages of paying themselves a wage or taking drawings from their business. Do you think like a businessman or more like an employee?
My response to them, in a nutshell, is this:
Business owners are NOT employees and therefore should not be taking a wage.
Here’s why: employees receive a wage for the work they do based on some agreed criteria i.e. a job description. They have set hours of work and are accountable to their employers for their standard of work. There is no risk in what they do, as the risk is borne by the employer nor is there any financial investment. Employees are remunerated for the work they do with wages / bonuses.
Conversely, business owners risk everything and have a significant investment in the business. Business owners work for themselves. They work countless hours in a role that is so wide and varied it cannot be put into a job description and they work for profit i.e. a return on investment (ROI).
If wages are taken this reduces the amount of profit that the business makes and effectively tax is paid on both the wages throughout the year and profit made at the end of the year.
In my opinion, business owners should therefore be taking drawings, which are an advance on any potential future profit.
Profit can be taken by a business owner in a number of forms that should exclude wages, such as drawings if a sole trader, profit distributions if operating as a partnership, trust distributions if operating as a trading trust or dividends if operating as a company.
The benefits of taking drawings as opposed to wages are:
- that you can decide if we want to pay super (i.e. it becomes a strategic decision as opposed to a government obligation)
- you can mitigate the tax on profits via effective tax planning measures and
- you don’t pay tax any earlier than necessary i.e. wages tax (PAYGW) is paid either monthly or quarterly.
Is this purely a deferral mechanism? In some cases yes, it is however, in others it is a genuine tax saving.
By taking drawings (which is really just an advance on your estimated 30 June year end trust distribution or dividend) it affords the business owner and their accountant the flexibility to determine the most effective use of funds and tax efficiency ensuring that you will never pay any more tax than is necessary or any earlier than required by the ATO.
With effective tax planning clients can alleviate the fear of not knowing whether or not they will have enough money in the future to pay the tax.
That’s why each year in May/June we contact all of our clients to offer them the opportunity to undertake a tax planning exercise, so that they understand their obligations and gain the answer to three simple questions:
- how much tax will be payable
- which individual/entity is liable for the tax and
- what date the tax is due and payable.
This enables us to estimate taxes 18 months in advance. Clients that avail themselves of this service are never surprised when their tax obligations are due and payable. Tax ‘shock’ is therefore eliminated with tax planning, and planning is crucial for those who wish to learn how to think like a businessman.
If you need advice specific to your circumstances, looking for business advisory services, or would like to know more about how to think like a businessman, please don’t hesitate to give me a call on 07 3391 1188 or email me: firstname.lastname@example.org