Paying Yourself as Business Owner

Reason to Start Own Business

One of the main reasons behind setting up your own business is to earn profits and even though it is an obvious fact, most of the entrepreneur faces with this question during his initial years of operation. Mainly because this question has multi-dimensions such as should you pay yourself just enough to keep going or should you be rewarded for your efforts early on or should you pay yourself from the revenue and while industry experts are in favor of keeping your pay at a conservative level for initial few years, there is no definite and concrete answer for the same yet because setting your own salary will depend on various factors such as your location, industry, profits and your expectation or how much you want to earn.

Factors Consider for Business Owner Paid Salary

Also as a business owner you have to ensure that you are neither underpaid nor overpaid and there are various factors one should consider before setting up remuneration for himself such as what can the business afford, what is your worth, what are your expectations and how much do you need to maintain your lifestyle.

Read More: : Tax Saving Solutions for Limited Company Business Owners

If you are a novice in the business world and have just started your business, then chances of getting profit in the very same year is extremely less or may be nil. However, it doesn’t mean that you don’t have to pay yourself because even if the profit has not yet knocked at your door, you are putting your efforts and time in order to establish and run the business and thus you shall reward yourself for the same.

Rewarding yourself not only caters on financial level but also on emotional and personal level because it is a world known fact that money is a big cause of stress, which is very much not a desirable trait to run your business successfully. Underpaying your efforts, time and work you are putting in to your business can harm your productivity, decision making skills and mental peace.

As per the United Kingdom guidelines, you have the freedom to start your business either as a sole trader or a limited liability company or partnerships and while a percentage of entrepreneurs choose to start as a sole trader or in a partnership, majority of them opt for limited liability company mainly because of the protection it offers to its directors from any kind of liability towards company debts. As a limited liability company, you and the company are two separate legal entity and thus you, as a director of the same, is not liable to pay company’s debts or credits from your personal accounts unless the debt is because of your negligence, fraud or dishonesty.

However, you need to be careful while deciding on the salary or the wages for yourself and your fellow directors, if any because industry experts believe that putting yourself and other directors on the monthly wages or on the payroll with full salary is not a very efficient way of handling tax and will also end up eating a fair share of your cash reserve. Also as a company director, you are a separate entity from your company and the profits coming are not automatically going to you mainly because company as a separate legal entity has its own share of liabilities, assets and legal status and in order to have a clear picture of where you stand, you must remember the distinction of your role as a director and a shareholder i.e. as a director, you will be responsible for managing the company whereas as a shareholder, you own either a part or entire company entitling you to the business profits and gains made if the company is sold.

Paying Business owner Income

Paying yourself as business owner can be a complex thing to get your heads around, however with a little bit of guidance, planning and foresight you can set up a highly effective and tax-efficient way to pay yourself from your business and one can think about the below mentioned considerations:

• Paying yourself through Pay As You Earn (PAYE): This is also the conventional method of paying yourself as business owners where you keep a certain and fixed amount aside for yourself from the regular income of the business. However, in this approach you become liable to pay PAYE income tax and National Insurance Contributions (NIC) depending on the amount you are keeping for yourself and thus might end up paying nearly 45% on your salary which takes you quite far from being tax-efficient unless you keep your monthly salary that covers the ongoing or current National Insurance contributions i.e. £8,424 per annum £702 per month.

• Paying yourself through dividends: The basic difference between paying yourself through PAYE and through dividends is that former one is applicable to the revenue generated from your business whereas the later one is applicable on the profits and not on the total revenue and thus is a more tax-efficient way to pay yourself as business owners. Dividends are typically paid only once or twice a year. As per the taxation policy of UK, corporation tax which is at present 20% is applicable on the profits and if you are earning or paying yourself above the prevailing dividend allowance i.e. £2,000, then you will taxed at the rate of 38.1% on it and is applicable over and the corporation tax you have already paid on your profit and thus makes paying yourself through dividends a less attractive offer. If your income is above the dividend allowance, you are liable to pay tax at the following rates:

  • 7.5% on dividend income within the basic rate band
  • 32.5% on dividend income within the higher rate band
  • 38.1% on dividend income within the additional rate band.

  The basic procedure for issuing a dividend is as below:

  • Before you issue dividends for yourself, you need to ensure that there is enough cash in the company’s account and in order to do so, you can print a balance sheet and profit and loss of the required period.
  • You must keep the fellow directors informed regarding the account status and also about your decision of paying yourself and the fellow directors through dividends.
  • Issue the dividend payments and the tax vouchers and accounts in the registered office.
• Pensions: As a business owner or a company director, you can also think of taking a pension plan rather than paying yourself through PAYE or dividends. Taking out a pension plan allows you to take money out of your business and also work on your long-term financial security because when you add into your personal pension scheme, you are progressing towards building a strong retirement plan. However there are certain tax restrictions which you must abide by i.e. if overall size of your pension fund is more than £40,000 per year then you are liable to pay income tax on the same. Also, once you reach 55 years of age you might have to draw drown up to 25% of your pension fund.
• Loan from the business: Another way to have a quick access to the money is to take loan from your business for a certain time period. However, as a director or business owner, you need to first set up a director’s loan account which will have all the details of the loan taken by you and of the money you have paid back to the business. Here you must be careful enough to not to go overboard and end up having an overdrawn directors loan account because if you fail to repay the entire amount within the decided or agreed time period, you might attract a Personal Liability Notice (PLN) from the HMRC. Also, you are liable to pay income tax at the rate of 20% on the repayment amounts as per the HMRC guidelines.

You as the owner of your business can choose any of the above mentioned methods however the very first step you should take is to separate your personal and business expenses and make sure that there are different accounts for both. A clear and defined distinction between personal and business account is a must for you to determine if your business is profitable or not. Also while you decide to pay yourself, you must do so in a tax-efficient manner i.e. you must calculate if paying yourself as a business owner is worth bearing personal allowance for income tax £11,500 and the dividend allowance.

In order to not to overpay on tax, most of the business owners pay only a small salary through income tax and take more if required as dividends because as mentioned above, you will end up more tax in the case of PAYE and less in the case of dividends. However, not every situation is same so there is no common yardstick or benchmark to decide which method is best when it come to paying yourself as business owners so in order to take your best call, you must consult your accountant because he can provide you clear picture regarding company finances and your salary as well.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.