How to pay yourself if you are a small business owner – Part 1
Photo title: Money being cut into many pieces. Source: TaxCredits.net
What is the most tax effective and correct way to get the profit of your business in your personal bank account?
This is a problem that numerous small business owners struggle with. I will attempt to clarify some of the issues relating to this, give advice on the correct practical way to handle the profit extraction and the tax implications thereof. This will be done in a series of blog entries. At the end of each entry I will give the business owner a practical change to implement in his/her business.
I would first like to clarify that if the business trade as a sole proprietor, I will still refer to the business as a separate entity. Substance over form, the business is still a separate entity although it has the same legal personality as the owner.
Sole proprietors frequently have one bank account for their business and their personal account. This causes a lack of segregation and at the end of the day there is no transfer of cash from the business to the owner, as the cash is already in the account of the owner. A situation like this makes it very difficult to keep track of how much money the owner is actually receiving from the business.
Although this was not possible at all banks in the past, it is now possible to open a business account when the entity has a legal form of sole proprietor. I have verified that is possible at FNB, I am not sure about the other major banks. If your current bank does not allow this, they will allow a cheque and savings account or an additional savings pocket. You can then use one of the accounts for business and one for personal.
The bottom line is that there needs to be an actual transfer with a paper trail from business to owner.
Close corporation or Private Company
This type of legal entity will have a separate bank account in its own name. The danger here is that the owner uses the business account to pay for personal expenses. This is not illegal, but it creates a lack of segregation and increases the administrative burden of processing the bank account of the business in the relevant accounting software. If this method is used the loan account of the owner (which will be debited with each personal expense) will give rise to a deemed dividend if it has a debit balance, this will be discussed under the tax consequences.
Also here I strongly recommend that there is an actual transfer from the business account to the personal account of the business owner.
Practical change to implement for part 1
Whether you are a trading as a Sole Proprietor, Close Corporation or Company, you need to implement discipline in your business by doing an actual transfer from the business account to your personal account whenever you extract profit to yourself. When you do this transfer on your internet banking, clearly label the description something like “Profit Distribution – Name – Month” or “Salary – Name – Month”.
Author: Chris Herbst