(5 Minute read – shareholder salary)
Hi there accounting fans!
Let’s talk about how you can pay yourself as a shareholder of your company. Please note that this article contains NZ specific tax advice.If you live outside NZ, your local tax department may have some similar rules, so it is best to check with your accountant first.
This article will focus on the technical aspects of declaring personal income as a shareholder of your company.
With that, let’s jump in!
What is ‘Shareholder Salary’?
Shareholder salary is an amount that you pay yourself (and other shareholders) for the work that you have done for the company. It is a representation of the blood, sweat and energy you have put into the business. This is your remuneration as a shareholder.
If I pay myself a PAYE salary – is that ‘Shareholder Salary’?
No, it’s not.
A PAYE salary has tax deducted at source. Apart from that, a PAYE salary also means that you are an employee of your company. This also means that your company is legally obligated to ensure that you are paid a minimum wage. This means that regardless of whether the company profits or not, it still has to pay you.
Also, your company needs to go through the whole rigmarole of being a registered employer. Then you will need to file monthly PAYE returns to the IRD. Then you need to make sure that you have a payroll system setup. Etc, Etc, Etc.
It’s a whole lot of trouble to go through JUST to pay one person. It may make sense to get yourself on the payroll if your team grows larger and/or you want a more systematic way to pay yourself and other shareholders. If you are a one-person show, don’t waste your time with a PAYE salary!
Then, what’s the alternative?
The alternative is to pay yourself via drawings. Drawings are cash or other assets withdrawn from the company’s account for personal use.
Click here for a simple 3 step guide to pay yourself using drawings
Drawings, unlike PAYE salary are not taxed. At all.
WAIT WHAT???? Drawings aren’t taxed???
Hold on, hold on.
There’s no way that the IRD is ever going to let you get away without paying your fair share of taxes. So let’s go back to talking about shareholder salary. Shareholder salary is typically used as a rough representation of the drawings you’ve taken out of the business. Shareholder salary, unlike drawings, is totally taxable.
How does shareholder salary work?
Shareholder salary is a year end accounting adjustment (typically made by your accountant if you have one). Shareholder salary comes out of the profit left in your business. Let’s use an example:
Terabyte ltd has made a profit of $60,000 for the financial year just ended. Terabyte has one sole shareholder, Terry. At the end of the financial year, Terry gets his accountant to declare a shareholder salary of $60,000 paid to himself (Terry). This effectively wipes the profit from Terabyte Ltd’s accounts and leaves it with $0.00 profit.
From the example above, this means that Terabyte Ltd doesn’t pay any taxes (28% of $0 is still $0). However, Terry now has a personal taxable income of $60,000 declared in his name. Terry has to pay taxes on this $60,000 using the IRD personal tax rate. So he’s looking at an effective tax rate of about 18.3%, which is much lower than having to pay taxes on company profit of 28%.
It is important to note that shareholder salary doesn’t involve any physical cash being transferred to the shareholder at the end of the year. Rather, it is merely an accounting adjustment to reflect the work put in by the shareholder.
What is the relationship between shareholder salary and drawings?
Drawings are simply assets (usually cash) taken out from the business by the shareholder for personal use. From an accounting point of view, this decreases your owner’s equity in the business.
Shareholder salary is an accounting adjustment made which roughly represents the work put in by the shareholder. From an accounting point of view, this increases your owner’s equity in the business. Think of it as the monetary value of your time investment into the business.
For more details on how equity and the shareholder’s current account works, read this article!
This is why the Shareholder salary adjustment can serve as an approximation of the drawings you take out of the business.
So yes, while drawings are not taxable, shareholder salaries surely are. So the tax department still gets their cut in the end.
How much can I pay myself through shareholder salary?
There is a legal requirement that if you choose to pay yourself a shareholder salary, you will need to do your best to make sure that you are paying yourself a ‘market rate’ for your services.
Bearing in mind that you can only pay yourself a maximum of whatever profit is left in your business at the end of the financial year. You cannot put your company into loss using the shareholder salary adjustment. So if you have only $10,000 profit in your company, you can only declare a shareholder salary of $10,000 at maximum.
These rulings are in place to prevent individuals from committing tax avoidance using shareholder salaries (a big No-No).
For example:
Terabyte Ltd has had a pretty good year and has made profits of $120,000. Terry the shareholder decides to be cheeky and only pay himself $48,000 in shareholder salaries which puts him just below the 30% personal tax bracket. His accountant tells him off for doing that and says that he should be declaring a market rate for his shareholder salary of at least $90,000 (which is closer to what he would normally be paid if he was working in the industry). This still leaves $30,000 profit in the business to be taxed at the corporate tax rate of 28%.
Awesome – so I should pay myself using shareholder salary/drawings now?
If you are the sole shareholder-director of your company – I would say it is the best way to pay yourself.
However, as your company grows, you may find that having a systematic payroll system works better and putting yourself on that payroll may save you some headache at the end of the year. But until you get to that stage, the shareholder salary is a flexible and easy to use system that allows you to declare income in your personal name for the work that you’ve done for the company.
If you need to have a chat or discussion about shareholder salary – drop me a message at our corporate website, www.shadvisory.co.nz
In the meantime,
Stay positive!
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