Turning your passion or trade into a profitable company is hard work. And as its Director you’ll face a raft of new responsibilities and challenges.
Of course, once your company is established that Director’s income will be a sweet reward for all that hard work. But what about when you’re just getting started? How much should you get paid then?
And what if your company isn’t making enough money to pay you the salary you’re expecting? Should you still receive one? If you do, will you be forced to pay it back to the company?
Knowing the answers could save you from an awkward conversation with your accountant about paying yourself more than the company can afford.
How much can you pay yourself?
As both the company’s Director and one of its shareholders, you need to ensure it has enough money to grow while still being able to cover its costs. But you also need money to cover your own costs—mortgage repayments, food, utilities, etc.
Ultimately, it’s a balancing act. Out of whatever profit the company has made, how much of it should be kept to grow the company, and how much should be used to pay your salary? But remember: if you take more than whatever profit the company made, it could experience profitability, cash flow or solvency issues.
Of course, the advantage of having a company structure is that it limits the Director’s personal liability for its debts. Though if the company fails you’ll lose any personal funds you invested, and you may also be liable for debts which you have granted personal guarantees for.
If you’re not sure how much your company can pay you, talk to your accountant. As you’ll learn in our next blog, you really shouldn’t take a salary that your company can’t afford. And if you need a higher salary than your company can afford, find out the revenue it needs to make so you can get the salary you need. (Your accountant should be able to help you calculate this figure.)
Two ways company Directors can be paid
Chances are your accountant will advise on the best way to be paid. But it’s important to understand how Directors’ wages are accounted for.
Generally, you can receive your income in one of two ways:
1. Receiving a regular salary as an employee. The company will withhold PAYG tax from your salary, and remit it to the Australian Taxation Office (ATO).
This is generally considered the least tax-efficient way to be paid. However, lower salaries can be balanced with dividends. And it’s much easier to manage and include in your company’s cash flow.
Yes, you’ll have higher BAS/IAS bills each month. But you’ll always know how much you’re getting (and how much you’re taking from your company), and you won’t have to pay anything extra on your personal tax return.
2. Drawing money from the company, which accrues as a Director loan account on its balance sheet1. As both the Director and a shareholder, you receive a notional year-end dividend from the company’s profits, which is then offset against your loan account.
While a loan account entry will always be created on the balance sheet, you’ll only be paid a cash dividend if the company’s profits exceed the loan balance account at year end. You’ll also have to deal with the income tax through your personal tax return, which usually results in a tax bill. And sometimes it can be a big one.
(Whichever method you choose, surplus profits can still be paid as a year-end dividend.)
These methods may seem quite similar. And the idea of drawing a wage without accruing an ongoing tax liability is certainly appealing. But there are some important differences, which we’ll step through in our next blog post about the risks of taking a salary your company can’t afford.
In the meantime, if you have any questions about the amount or method of drawing a salary from your company then don’t hesitate to get in touch with us.
1Also known as Division 7A loans (a reference to the tax legislation that deals with them).