- 2 Q&As on how the self-employed can make the most of KiwiSaver.
- More to come on tax deductibility of mortgage interest when you rent out your former home.
QMy wife and I are owners and directors of a small limited liability retail business. My wife works full time and, rather than take drawings from the business, pays herself a weekly wage as an employee and pays PAYE on that income. I work part time for the business and take no income.
We have both signed up for KiwiSaver directly with a provider, ING. We each pay monthly contributions to the scheme and in my wife’s case the contribution is 4 per cent of her gross income.
We did this as we wanted to go with ING rather than a default provider that IRD may have allocated. Also, we have plans to sell the business in the next year or two, which makes it easier to make ongoing contributions ourselves, directly to the provider.
My wife has received a letter from IRD stating that as she is classified as an employee, the company has to make KiwiSaver deductions from her wages. We also received another IRD letter, this time addressed to the company, stating that the company has to make deductions of 4 per cent from her wages and, since April, also make 1 per cent employer contributions.
This all seems very complicated. We were trying to keep it simple by making our contributions direct to the provider, who has informed IRD and requested they update their records, so IRD is aware we are making direct payments. However, for some reason they still want my wife to make payments through them.
We would very much appreciate your advice as to what we should do.
AAs Fred Dagg might put it, “You don’t know how lucky you are”. Other self-employed people are considering going to considerable hassle and expense to be in the position your wife is in.
True, having to do what Inland Revenue is telling you is more complicated. And you do have to do it that way. For anyone who pays PAYE, KiwiSaver contributions go via Inland Revenue to their provider. The idea behind this was to make life easier for employers — although in small companies that may not be the outcome.
Still, once you have things set up — and Inland Revenue should give you guidance on that — it shouldn’t be too different from now. And your wife and your company stand to gain more than $1,000 a year — possibly considerably more — from the government.
To show why, let’s take a look at the situation for all self-employed people.
Many self-employed people — who are classified as sole traders — are in the same flexible circumstances as other non-employees. They should join KiwiSaver, even if they contribute nothing, to get the $1,000 kick-start. But it’s better if they contribute $20 a week, or $1,043 a year, to make the most of the member tax credit.
However, it’s different for self-employed people who are “shareholder-employees” — a term used in the tax system. A shareholder-employee works for a closely held company — in which five or fewer people own more than half the company — and typically receives irregular pay, as opposed to a regular amount each week or month.
If you are a shareholder-employee, usually you can choose between paying provisional tax by instalment or having PAYE deducted from your pay — although in some cases you have to go with PAYE.
If you pay provisional tax, you can join KiwiSaver directly through a provider, on the same terms as sole traders and other non-employees. Compulsory employer contributions don’t affect you. But if you pay PAYE — as does the wife of our correspondent — you are treated like other employees. This means:
- If you start a new job as a shareholder-employee subject to PAYE, you will be automatically enrolled in KiwiSaver, although you can opt out if you wish.
- If you are a contributing member of KiwiSaver, the company — which in a one-man band may simply be you — must make compulsory employer contributions, which are not taxed.
- Through the employer tax credit, the company will be reimbursed for its contributions up to the amount that it contributes or $20 a week, whichever is lower.
- Any excess in employer contributions above that reimbursement is tax deductible to the company and not taxable to the employee.
Many self-employed people are eyeing the third item on that list. If they are not shareholder-employees paying PAYE, they are thinking of changing to that status. They will then be reimbursed for up to $1,043 of the money they, as employers, put into KiwiSaver each year. They get two tax credits — one as an ordinary member of KS and the second as an employer.
Note, too, that there is another gain because employer contributions are not taxed — as long as they are no more than an employee’s contributions or 4 per cent of the employee’s total before-tax pay, whichever is less.
That means that shareholder-employees paying PAYE can convert some of the company’s taxable income into non-taxable money in KiwiSaver.
For somebody earning $100,000 and contributing $4,000, the company could also contribute $4,000. That’s higher than the current compulsory employer contribution level, but it’s permissible. The company would be reimbursed $1,043, and the remaining $2,957 would not be taxed. At the 30 per cent tax rate, that saves $887 in tax.
Despite these gains, experts say that it probably makes sense to change status only if there are other good reasons to do so. If you change from a sole trader to a shareholder-employee just to get an extra thousand dollars or so a year from the government, you might well find that the gain is more than offset by the extra admin in your life, to say nothing of higher accountancy fees and other costs. There’s a lot to be said for the KISS idea — keep it simple, stupid!
Even if you are already a shareholder-employee, but are paying provisional tax, you should hesitate before switching to PAYE. With provisional tax, you tend to pay the tax later, so you get the use of the money in the meantime. The interest you earn on that money might outweigh — or at least eat into — the advantage you would gain from moving to PAYE.
In the case of our correspondent, though, his wife is already in the right spot to gain the $1,043 plus tax breaks each year.
By the way, just in case any shareholder-employee is thinking of paying PAYE on $26,000 of their income and provisional tax on the rest of it — which would make the employer contribution fully reimbursed — that’s not OK. You must pay all the tax on your employee income either by PAYE or provisional tax, not a combination.
Meanwhile, our correspondent — as opposed to his wife — would be regarded as a non-employee as he is paid no income. So you can continue with your current arrangement with ING. Once you’ve sold the business, your wife can switch back to her current arrangement, unless she is employed by someone else.
A couple of final points:
- Given that you work for the business you might want to look into paying yourself something, and perhaps reducing your wife’s pay by that amount. Depending on your other income, it might well reduce your total taxes. Also, you could gain some of the same advantages as your wife — the KiwiSaver tax credits and tax-free employer contributions. I suggest you talk to an accountant about it.
- It sounds as if you think that all employees, whose KiwiSaver contributions go via Inland Revenue, are allocated to default providers. This happens only if a person doesn’t select their own provider.
QMy accountant and I were talking about KiwiSaver and employer contributions.
I said my understanding of your book is that the self employed who run their business through a company can have the company make contributions to its employees’ KiwiSaver accounts provided the employees pay PAYE. The company would then be reimbursed by the government up to $1,043 a year.
My accountant said that’s how it was originally set up, but the IRD now appear to regard this as an unintended loophole and will be announcing soon a variation which may see the loophole closed.
She wondered if you had heard anything. She seems to think it is not some closely guarded secret but rather something the IRD may have already decided and will disseminate at its leisure.
AYour accountant might have to try some new gossip circles. Not only was the idea of an Inland Revenue clamp down news to me, but to an Inland Revenue spokeswoman. “We haven’t heard anything, and I would think we would be the first to know,” she says.
The department has checked the previous Q&A for accuracy, and says it is all correct. And, when you think about it, why shouldn’t a one-person business get the same government reimbursement as a larger one?
QI am intrigued by your answers last week about tax deductibility of interest originally borrowed to fund a family home when that home converts to a rental. There is certainly a large degree of confusion about this issue.
While I am not disputing your experts I do find it intriguing that on the next page of the Herald to your column, Diana Clement quotes an accountant as saying “The IRD only allow you to deduct the amount that was actually borrowed to fund the purchase when you purchased it”. It appears to me that there is no consistency in the advice that professional people give. So what hope is there for the rest of us?
AYou might well ask. You’re not the only one to raise this, and I’ve sent some readers’ letters to Inland Revenue.
Their response: “As a result of the points that have been raised by readers following your column, we are taking an in-depth look at the technical aspects of this matter, and we will provide a fully considered response”.
I’m hoping that will come in time for next week’s column. If not, look for it the week after.
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Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.