How to Remunerate Yourself in a Small Business

All small business owners will, at some point in time, have to consider how best to extract money from their business into their personal structures. Extracting profits from a business is usually a key taxing point for most business owners and doing this in a commercial and tax effective manner will be critical for long term wealth generation. But what is the best way of taking this money out of your business?

As accountants and trusted advisors, we are often approached by our small business clients for guidance on this subject and in our experience, it is not a “one size, fits all” solution and depends upon a myriad of factors.

In this article we touch on some different business structures and ways in which small business owners, might look to remunerate themselves, including the practical and tax considerations in doing so.

Sole Trader

Remuneration

As a sole trader, you would typically remunerate yourself by withdrawing funds from the business as and when required (You may often see this represented in your financial statements as ‘drawings’). You are not considered to be an ‘employee’ of the business and whilst you can employ other people, you cannot employ yourself.

How much?

The income of the business, after deduction of expenses, is effectively your money. However, as the business owner you are also responsible for making sure that there is enough money retained within the business to ensure that your business can grown and continue to operate.

From a practical perspective, the amount you withdraw from the business is going to depend upon the business’s working capital requirements and the minimum amount of cash that you might require to meet your own personal obligations and to support your family.

Where your business cashflow is consistent you could seek to withdraw a set amount periodically, which could be adjusted upwards or downwards in future periods, where cashflow might be slightly higher, lower, or a little more erratic.

In our experience, taking out a regular amount from the business can often be much easier to manage, particularly where you may have previously been an employee deriving a regular wage, before starting your own business.

Additionally, although it is not a requirement for you to have a separate bank account for the business, it can make it much easier to track the business income and expenses.

Taxation and Other Considerations

As a sole trader, you will pay tax on your business’s taxable profits regardless of how much money you have taken out of the business. As such, it would be prudent to set aside some funds to ensure that you are able to meet your tax obligations as and when they fall due.

You are not required to pay any superannuation as a sole trader; however, you might wish to make personal contributions to your fund to help build up your retirement nest egg. Your personal superannuation contributions might also be able to be claimed as a deduction in your income tax return.

General Partnership

Remuneration

As a partner in a small business partnership, your situation is very similar to a sole trader, where you would withdraw funds from the business in order to remunerate yourself. The amounts you withdraw are not wages for tax purposes, nor are you an employee of the partnership.

As a partner you are entitled to your share of the business profits, which may be outlined in a partnership agreement or may be something that you have verbally agreed with the other partners based upon your participation in the business.

How much?

The funds that you and the other partners withdraw from the partnership is likely to be a mutually agreed amount for each partner, after consideration of the business’s working capital requirements, , any future plans for investment or growth, together with the level of participation of each partner in the business (particularly where one partner may not be part of the day-to-day running of the business).

It is likely that before going into partnership you will have already considered how much cash you need to support yourself and the amount that you have agreed with the other partners to draw from the business will align with this. This might be an amount that is benchmarked against the salary of an employee in the same or similar position or may be an amount that you may have previously been deriving as an employee.

There may be occasions where you might need to withdraw additional funds from the business to help meet your personal obligations. In a partnership (Unlike a sole trader) the cash retained by the business no longer just belongs to you and you might need to agree any additional drawings from the business with the other partners.

Taxation and Other Considerations

The partnership may complete a tax return, however, the partnership itself does not pay any tax.

As a partner, you will need to complete an income tax return and include your share of the business’s taxable income, regardless of how much cash you have withdrawn from the business. You will be taxed on this, together with any other income that you may have earned outside of the partnership.

Like a sole trader, you are responsible for paying the tax on your share of the partnership income and should seek to set aside funds to meet your tax liabilities as and when they fall due.

You are not required to pay superannuation on your partnership income; however, you might want to make personal contributions to your fund. These personal contributions might be able to be claimed as a deduction in your tax return.

Company

Another common structure that we see a small business operated under is a company structure, where the directors run the company and the company is owned by the shareholders (which can be the same person or related parties).

Unlike a sole trader or partnership, the profits of the business belong to the company (not you as an individual) and where you are a director, shareholder or associate of the company, there may be tax implications of withdrawing funds from the business.

Remuneration

For remuneration purposes, we will look at a scenario where you are both a director and a shareholder in the business. The methods outlined below are not an exhaustive list.

Salary and Bonus

As a director of the company the most common way to remunerate you is with a salary, whereby you are an employee of the business. Your employer (The company) pays you a gross salary and withholds tax (Also known as pay as you go withholding tax) from this, with the net amount paid into your bank account as net wages. The tax withheld is then paid to the ATO on your behalf and superannuation (currently at 10.5%) is calculated and paid into your nominated superannuation fund by your employer.

Where cash may start to build in the business, you may decide to pay yourself a bonus from the business, which would still be subject to withholding tax and super.

Company Car

In addition to your salary, or as part of your salary ‘package,’ the company may also provide you with a company car to use for both business and personal purposes.

Where a company car is provided this may give rise to fringe benefits tax and a reportable fringe benefit to you. The reportable benefit is not included in your taxable income, however, is considered by the ATO for certain income tests. Further to the recent budget announcement, the company could seek to provide you with an FBT exempt hybrid/electric car (noting that at the time of publishing this has not yet been formally legislated).

Dividends

As a shareholder you may be able to remunerate yourself by paying yourself dividends, which are paid out of the company’s retained earnings. You receive your dividends net of a franking credit (currently 25% for a small business).

Additional Super

The company could seek to pay superannuation to your fund which is above the statutory rate (Currently 10.5%) to take you up to your concessional contributions cap (Currently $27,500).

If the company pays additional superannuation for you to take you up to your concessional contributions cap, this would be required to be reported as reportable employer superannuation contributions in your tax return. This is not taxed as income but is considered by the ATO for certain income tests.

Combination

You might also seek to remunerate yourself via a combination of the above

How Much and Tax Considerations?

Many business owners will want to pay themselves a market salary for the position that they have in the business, however, it is not always that straight forward and there may be sounds commercial reasons why this would not be the case (growth, cashflow, etc.).

Any amounts not paid by salary and wages will usually form part of the profits of the business and can be paid out as dividends.

Any dividends that are paid to you by the business come with franking credits attached (often franked at 25%) and in your tax return your taxable income is ‘grossed-up’ by the franking credit.

What this means is that even though the business may have paid you say $50,000 as a dividend, your taxable income would be $50,000 plus a franking credit of $16,667 = $66,667. You then get a tax offset for this amount against your tax payable.

There is no right or wrong combination, however, the amount and remuneration type will very much depend upon the business needs and your own personal circumstances.

In Summary

As you can see from the examples and considerations provided above, there are many ways in which a business owner can seek to remunerate themselves.

How you seek to do this is very much governed by your business structure and may be impacted by both business and personal circumstances.

Picking the right structure initially, and ensuring that you get the right mix of remuneration will ensure that you achieve solid commercial and tax effective outcomes. 

Written by Julia Keeble