What are the best ways to pay yourself as a business owner?
When running your own business, it’s liberating to know that you are in total control of all aspects of your workplace. There are many positives to running your own business, but also some challenges you might not have considered. For example, how do you get paid?
As a business owner, it’s important that you get to grips, as quickly as possible, with the concept of paying yourself. There are a few ways of paying yourself as a business owner, and we’ll look at them closely below.
Paying yourself as a business owner
Starting off, you should look to set a clear limit as to how much you can be paid yourself. It’s important that you don’t pay yourself too much. The general rule of thumb is that you should only pay yourself from profit, not from your revenue. This makes it much easier for you to ensure you never pay yourself too much and risk the liquidity of your business.
You need to take into account things like payroll costs, overheads and also taxes. If you keep that in mind, then you can avoid paying yourself too much. Working with an accountant will help you to work out how much you should be taking out of your business. This will help you to work out what you should be paid minus all the other associated costs with what you do.
It also helps to set up a regular payment slot, so that your wages are paid weekly or monthly.
With that in mind, how do you pay yourself, exactly?
Salary or draw? What’s the best option?
It would depend on how you have set up your business in the first place. For example, a lot of people might choose to run their business as a sole trader, while others might choose to run as a limited company. As a sole trader, all profit earned is your own. This is different from taking a wage and is classed as ‘business drawings’. However, you will also need to make sure that you don’t spend too much, as you will be liable to handle the tax bills for that money. Any profit or income for your business is taxable. We recommend that you try and put away 25% of all earnings, as this will likely cover the majority of your self-assessment tax bill at the end of the year.
If you are a limited company, the rules change quite considerably. The current tax-free personal allowance for 2018/19 is £11,850, so if your salary is lower than this amount you will not attract any PAYE income tax to pay. You company will pay 13.8% NICs on salaries paid in excess of £162 per week or £8,424 for the year; so the optimum amount of salary to avoid NICs is £8,424 per year. If you are paid a salary above the Lower Earnings Limit of £6,032 for 2018/19, then you will need to register as an employer through the Government. You’ll be given a PAYE number and an activation code for your PAYE, meaning that you can then set up the payroll.
You also have two options – you could either pay yourself a standard salary, as mentioned above, or you could take an owner’s draw as compensation. An owner’s draw is when the business owner will take funds out of the business to use for themselves. Rather than paying yourself a direct salary, many small business owners choose to go down the route of using a draw instead. This is normally either company profits that you tap into, or taking back money that you personally invested into the company in the past.
If you choose to use a draw, then you will need to pay tax on these earnings. This will be as income on your own personal tax return. The decision, then, comes from whether you wish to automatically pay your taxes on a salary, or whether you wish to pay taxes on the draw.
PAYE and dividends
We mentioned PAYE earlier. It’s going to see your income taxed at source via the employer. If you have been a company employee in the past, then you will already be aware of PAYE taxation. If you choose to use PAYE to pay your taxes, then you will have to decide upon your gross amount of income that you want to pay as your salary. Then, calculate your tax and National Insurance costs accordingly.
The other option that you could use is that of a dividend. These are payments which will be made to shareholders out of the profits posted by the company. Many business owners will pay themselves with a dividend, but you cannot do so if your business did not turn a profit.
Dividends will be taxed for corporation tax and then income tax once the dividends are shared out among shareholders. At the time of writing, there is a dividend allowance that will cover as much as £2,000 (2018/19) before having to pay tax. Dividends can be a tax-efficient payment method as they do not attract NICs but working out how much you should pay yourself in dividends and how much as a salary is the real challenge.
Making the right decision for your business
Of course, making the right decision on what would be the right choice for you personally can be tough. If you are unsure of what payment method might be good for you, then you should seek our professional advice.
At Devonshire Green, we can evaluate your business and help you to determine the right choice for you. Every business is different, and the payment options open to you will need to be evaluated on a case-by-case basis. If you are interested in getting the right payment structure in place, then contact us today.
We can help you to pick the payment and salary plan which is best suited to your business.