Drawing a salary from your business is a crucial decision for many business owners, affecting both personal finances and the financial health of the business. As a tax agent, I’ve guided numerous clients through the complexities of compensating themselves in a manner that’s both tax-efficient and aligned with their business strategies. This article provides an overview of the considerations and best practices for business owners looking to draw a salary from their business.
Salary: A salary is a fixed regular payment made by an employer to an employee, typically expressed as an annual sum. For business owners, taking a salary means you’re treated as an employee of the business, which entails payroll tax obligations like PAYG withholdings and superannuation contributions.
Draw: A draw, or owner’s draw, refers to the withdrawal of funds from the business’s earnings for the owner’s personal use. Draws are not considered wages for tax purposes; therefore, they don’t attract payroll taxes or superannuation contributions. However, the business owner must account for this income during the personal tax return process.
Tax Implications
The choice between drawing a salary and taking an owner’s draw has significant tax implications.
For Salaries:
– The business can deduct salaries as a business expense, potentially lowering the business’s taxable income.
– Salaries are subject to income tax at the owner’s personal tax rate and must be reported via the business’s payroll system.
– The business must remit PAYG tax withholdings to the Australian Taxation Office (ATO) and contribute to superannuation on behalf of the owner.
For Draws:
– Draws are not deductible as business expenses.
– Business owners must account for draws when calculating their personal income tax, paying tax on their total income, including the draw, at their personal tax rate.
Considerations for Business Owners
1. Business Structure: Your business structure significantly influences how you should pay yourself. Sole traders and partners in a partnership typically take draws, while directors of a company may take a salary, dividends, or both.
2. Cash Flow: Regular, fixed salaries require consistent cash flow. Evaluate your business’s financial health and cash flow stability before committing to a fixed salary.
3. Superannuation: Paying yourself a salary allows you to contribute to your superannuation, ensuring you’re saving for retirement. Draws do not facilitate superannuation contributions by the business.
4. Tax Planning: Consult with a tax professional to understand the tax implications of your compensation method and plan accordingly to optimise your tax position.
Best Practices for Drawing a Salary
1. Keep It Reasonable: Ensure your salary is in line with industry standards and reflective of your role and responsibilities within the business.
2. Document Everything: Whether taking a salary or a draw, document all transactions meticulously to ensure compliance and facilitate tax filing.
3. Separate Personal and Business Finances: Use separate bank accounts for business and personal finances to maintain clear boundaries between the two.
4. Regular Reviews: Periodically review your compensation strategy to ensure it remains aligned with your personal financial needs and the needs of the business.
Deciding between drawing a salary and taking an owner’s draw depends on various factors, including your business structure, financial stability, and personal financial goals. It’s crucial to consider the tax implications and legal requirements of each option. Consulting with a tax professional can provide valuable insights and help you make an informed decision that supports both your personal and business financial health.