In this Tax Tip Tuesday, we look at a question that business owners ask when making profits. How do I pay myself dividends?
This is part of our three part series on how do I take money out of my company?
A dividend is effectively a distribution of profits from the company to its shareholders. It is paid in accordance with the company’s shareholding. What this means is that if you and a friend each own 50% of the company, then the dividend should be paid out in that proportion.
One of the great things about the tax system in Australia is that when a company pays tax on its profits and they are distributed to shareholders as dividends, the shareholders can receive a credit for this tax already paid. The payment of these profits with tax credits is called a franked dividend.
Explaining this a bit further, for a dividend to be franked, the company needs to have enough “franking (tax) credits” to cover the dividend amount. This means that the company needs to already have paid tax on the dividend amount it is paying out to you.
As an example, let’s say your company is able to pay out a $7,000 in dividends. This can be seen be seen as:
Let’s say your company makes $10,000 in profit this year $10,000
Tax on companies is 30% ($3,000)
The profit after tax is calculated as $7,000
If there is at least $3,000 in the company’s franking (tax) account, then the dividend can be paid out to you as a franked dividend. Some examples of how an amount could be in a company’s franking account include; if the company paid PAYG instalments during the year or if they prepaid some tax before year end.
By paying out a franked dividend, you will get the benefit of the $3,000 tax already paid by the company in your own personal tax return. This means that the tax you are liable to pay in your personal tax return will be offset by the $3,000 in tax already paid by the company. When included in your personal tax return, the dividend of $7,000 is grossed up by the $3,000 and included as $10,000 of dividend income. Forgetting to gross-up the dividend is a common mistake small business owners make when completing their personal tax return.
This Tax Tips Tuesday is brought to you with love by Nudge Accounting. You can read other Tax Tips here.