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Help me understand paying myself please.

Discussion in 'Business Accounting & Tax' started by Propagate, 6th Oct, 2016.

  1. Propagate

    Propagate Member

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    Our new company, (2 of us are owner/directors and one staff), has been going for 4 months now.

    We’re a PTY LTD company.

    For the first 3 months we paid our staff wages & super etc whilst we worked for “free” to build a buffer.

    For the last month, now there’s a buffer in place, we have become staff of our own company and have started paying ourselves a salary too.

    It only struck me today that the main reason there is now a buffer is the three months’ worth of work we did for “free” resulted in the invoices creating the buffer, (profit), but as we did not draw a wage we will ultimately pay company tax on that whole amount without the “expense” or our wages to offset against it.

    The original idea was that we would employ ourselves when we were sustainable to do so, then after year 1 we’d take a dividend from a portion of any profit left with the balance left in the company bank account as a buffer to smooth out the following year.

    Am I right in thinking we may have shot ourselves in the foot for not drawing a wage from day one whilst creating the income?

    Can we back-pay ourselves for the hours/work done in generating that profit or are we too late now that we have already paid ourselves a month’s wage, (company started beginning of June, we became staff of it beginning of September).

    Is it simply a case of changing our start date in Xero back to the start of the company, (or Say July 1st to keep it within this year), then running unscheduled pay runs to “catch up”?

    If so, is there even merit in this or would some kind of Directors Fee for those months be more suitable, (or even possible)?

    Can’t believe I didn’t think of it before, but it only hit me today that basically 2 of us, working our buts off 70 hours a week for 3 months for no pay to generate a decent starting buffer will get hammered with company tax on that whole buffer, (less operating costs), as we have not expensed our hours in creating it in the first place. Hope that makes sense?

    It’s not like those months were R&D or set-up months, we are structural draftspeople, to generate that profit we have both been producing something, (drawings), that generates an invoice for the service to the client. Very basically, each hour we “work” generates an hours sum of money which, for those first three months, now has no labour cost associated it with it.

    Cheers.
     
  2. Propagate

    Propagate Member

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    Am I overthinking it?

    If say, I back-payed myself or took the equivalent of as a bonus, and let's say the "missing" salary for both of us gross is $40k (at $20k each).

    Per person, the company "saves" 28% company tax on $20k as it is a claimable expense for generating the income. Tax saved by the company = $5,600

    I however now pay an additional 37% of the $20,000 via personal income tax = $7,400

    The net result is we've ended up paying more tax as the wages were to ourselves and not an outside expense.

    I think I'm caught in a loop and confusing myself, as in, if it was an employee other than ourselves that we were paying then the companies profit will reduce, and with it the tax payable leaving more for us to take as net profit (as dividends? with the complexities of franking etc but that's one to get my head around another day).

    ...but because "we" are the employees that generated the income then yes, the company technically makes less profit so pays less tax but as it came back to us as wage income then ultimately it costs us more tax in PAYG on the wages received anyway as an end result?

    Time for a lie down I think.
     
  3. Simon Hampel

    Simon Hampel Founder Staff Member

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    As directors, the term "staff" is kind of moot anyway.

    You can pay yourself whatever you agree is worth paying - doesn't have to be a regular salary, can be a lump sum if you like (you'll still need to take tax and super into account though either way).

    Whether you call it a directors fee or an employee wage doesn't matter.

    Salaries paid (including directors fees) are expenses to the company and will decrease the profit that the company pays tax on. But you don't calculate profit until the end of the financial year, so if you're talking about stuff that's happened after July 1, don't sweat it yet - you have until June 30 next year to play with the figures and minimise taxable profits by paying the directors.

    That's what I do just before the end of the financial year - work out what the net profit is going to be for the year and then pay myself a directors fee (plus tax and super) to make sure that profit is wiped out.

    Basically, pay each director up to around $80,000 each year (to remain in the 32.5% tax bracket) and then if there's more profit remaining at the EoFY, you decide whether to pay it out to directors (they pay more personal tax), or retain it in the company and pay company tax on it and then reinvesting it or paying it out as a franked dividend to shareholders.

    In my case, our family trust is the shareholder of my company, so I pay myself the first $80K of profit, then retain the remainder above this level in the company and then pay my trust a franked dividend which it then distributes to the lowest income earner (or more accurately, soaks up the carried forward losses from previous financial years within the trust :eek: ).
     
  4. Simon Hampel

    Simon Hampel Founder Staff Member

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    I guess the question is - how much profit did the company make before the end of June 2016?

    You may have scope to make a book entry for June 30th to pay yourselves enough to wipe out that profit and because you hadn't yet taken the cash, you just enter it into your books as a directors loan (the company owes you that money). Again, you'll still need to take tax and super into account, even if you don't receive the cash yet.

    You can either retain that cash in the company to help with cashflow (the money owed will remain on the balance sheet as a directors loan), or pay it out as a loan repayment once you have sufficient cash.
     
  5. RPI

    RPI Well-Known Member

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    Nice structure Sim.
     
  6. Propagate

    Propagate Member

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    Thanks for that Sim, much appreciated.

    I had wanted to stay at or under $80k but we worked our salary our based on what the minimum was that either of us needed to survive on, so ended up being a little over the $80.

    Good to know we can work it all out next year to make the best of the situation, I can sit down with our acountnat then and go through it properly.

    We are both the shareholders, 50/50 so seems like we would retain the profit in the company and pay out a prtion of it as a franked dividend to ourselves, leaving a chunk in the company to smooth out next year as a buffer.

    The company didn't make any profit prior to June 30 as we were only about 3 weeks old then, we had outlays and any work invoiced wasn't paid until after July so there was no income to the company in June.

    The next thing to get my hed around then is the franked dividends.

    I have not been able to get my head around how taking a dividend is more tax efficient than just paying the whole profit to ourselves as a wage/bonus whatever? The way I have it in my head, (very likely completely wrong but I have not been able to find an "idiots guide") is:-

    Example, say we've paid ourselves $80k wage through the year for arguments sake, so any more wages would now be taxed at 37c

    Option 1 - Say the company looks to be in profit by $100k, (would be nice!) so option 1 is we pay ourselves an additional $50k each of which we are taxed at a rate of 37c and the company makes zero profit effectively, this results in a net payment of $31,500 each (ignore super for now for sake of simplicity).

    Option 2 - We don't take any further wage/bonus so the company profit is $100k, which is then taxed at 30c and so off the $30k goes to the ATO. We then take the remaining $70k ($35k each) as a franked dividend so we end up with $35k net instead of $31,500.

    I don't understand how franked dividends work though, does the franking mean that the 30% tax paid already is in lieu of your personal tax rate regardless of your personal income bracket? Or, once that dividend is paid to us do we still end up making up the difference between the 30% company tax paid and 37% personal tax in our personal tax return, thereby ending up with the same net amount regardless of whether it was a wage or a dividend?

    Cheers.
     
  7. Simon Hampel

    Simon Hampel Founder Staff Member

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    My understanding is this is correct - if the company pays the tax and then pays you a franked dividend, you'll get a credit for the tax already paid and will just pay the difference based on your personal tax rates.

    If you are personally the shareholder, the net result will be the same either way - you can't avoid paying tax, but if you want to defer it - you can withhold profits in the company (and perhaps reinvest them into the business?) so the effective tax rate is only the company tax rate until you decide to pay them out later.

    This is why owning the company shares via a structure like a family trust is good - gives you a lot more flexibility in relation to income streaming (ie if your spouse was on a lower tax braket, you could stream the franked dividends to them and they will get a tax refund for the tax already paid by the company).

    Not sure if any of our members who are accountants have any suggestions to offer on the most efficient way to pay yourselves in Propagate's circumstances?
     
  8. Propagate

    Propagate Member

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    Thanks Sim, it makes sense and is broadly how I understood it to work.

    I guess the only potential benefit in disturbing via a dividend over a salary payment in our case would be not having to pay yourself super on top, (although if you paid your self a bonus I'm not sure super is payable on bonuses anway, just on ordinary hours?).

    We didn't set up a trust structure, so there's no distribution tweaking possible, (my partner earns more than me anyway so a moot point in our house just now).

    For us, we don't need further funding for expansion. We have office space, equipment and licenses to take on more staff than we'd ever need and expansion in this industry is simply a function of workload generally. We can chase more work whenever we want and staff up accordingly, (the work is there at the moment to do so), but it's not on our radar. Seen too many get too big too quick, (get greedy), then create a wages monster that can't be fed at the first sign of a downturn and they go broke, I've seen it over and over. We're happy with 3/4 of us and just want to get enough in the bank as a buffer to smooth out the late invoices and lulls.

    I get myself confused sometimes as it is very different to the UK, (where I'm from).

    When I had my UK company, (just me as a single director), you could pay yourself minimum wage, the company then paid corporation tax at flat rate 20% on profit and you took the profit with no further personal tax to pay regardless of what tax bracket you'd gone into from other income.

    There all sorts of legislation in the UK to attempt to clamp down on essentially employees setting up as sole traders and rorting the tax system as that 80% company profit does not get further taxed as personal income, it's a guaranteed income in effect and taxed in isolation.

    They have weird and wonderful ways of making you prove you are a genuine single person company whereas the simple solution would be to make everyone do a tax return (in the UK most regular salaried people don't need to submit a return), and do like here, tax everyone individually on their annual income, regardless of how and where that money come from. It would stop all of the single trader rorters overnight. Don't get me wrong, there are some genuine ones out there that have to work under a company structure, but the vast majority of "contractors" I have worked with in the engineering industry in the UK were out and out rorting, year after year.
     
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  9. Propagate

    Propagate Member

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    *guaranteed" income should have read "quarantined " income.
     
  10. Simon Hampel

    Simon Hampel Founder Staff Member

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    I think any payment which can be treated as salary (including bonuses) would also be subject to super.

    Actually, I just found this: How much to pay

    ... and this table: Checklist: salary or wages and ordinary time earnings

    Basically, Salary or Wages will have Superannuation Guarantee payments, but also any payment which is considered part of "Ordinary Time Earnings (OTE)", meaning the payment was related to your normal duties that you perform as part of your usual hours of work. That includes directors fees and most bonuses.

    The main exception would be for overtime, but only when the payment is exclusively and specifically made as an overtime payment, and similarly, bonuses specifically in respect to overtime work.

    So I think you'd have a difficult time convincing the ATO that you were paying the correct amount of super to yourselves, regardless of how you categorised it - unless you're very careful.

    In which case, you are correct - not paying yourself the extra income as salary and instead paying it out as a dividend payment will indeed allow you to reduce your superannuation obligations, I hadn't originally considered that!
     
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  11. Moyjos

    Moyjos Member

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    Without having read every word of the above posts.

    I go and see our accountant in March-April each year. We can then do a fairly good summary of the year and devise a plan for the last couple of months so to how much we need to take out in "wages" to make the best use of taxation benefits.

    Sometimes it is "carry on as normal" and sometimes it is "OMG!!! Spend up on something (materials,machinery, super) now!!!"
     
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  12. Terry_w

    Terry_w Active Member

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    Propagate you might want to consider selling your shares to the trustee of a discretionary trust sooner rather than later as the CGT will be lower. Once the trust is the shareholder you will gain flexibility. If your spouse is on a higher income now you can receive distributions. Next year the spouse's income may drop and so the dividends can be paid out to them.

    if the company goes well and profit is up you can divert the income into another company to cap the tax rate at 30%. This gets assets out of the trading company and therefore has asset protection benefits too.

    The bucket company can hold the cash and then pay it out at a later date with franking credits attached. This could be when your incomes are lower so there is more benefits in the franking credits.

    The bucket company could also build up a large sum and then lend this out to you or other entities to use for deposits to buy property or for other investments. This would require a Div7A loan agreement and benchmark interest paid, but this interest may be better than paying tax on the income. Also a compnay can lend to another company without Div7A loan agreements - potentially interest free. So you could have a third company set up to own property - which can work well in NSW as another land tax threshold is obtained.
     
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  13. Propagate

    Propagate Member

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    Thanks @Terry_w that's great info. Will file this is in the "Important" drawer. Cheers.
     
  14. pinkboy

    pinkboy Member

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    The first year you find you will pay a bit more tax as you don't fully understand how it all works. Then the next years you get smarter, more creative, and dodgy! :D:D:D

    pinkboy
     
  15. Paul@PFI

    Paul@PFI Member

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    Get a accountant who includes general guidance and advice without a hourly bill. You will suddenly realise how much you need to ask