Paying Yourself Tax Efficiently
Article by Alexander
When starting your own business, you need to be investing as much money possible in order for it to grow in its early days. Asides from the issues of growth, new business owners also need to take into consideration the fact that they will need to pay themselves. This is especially important in the first 12 months when money will usually be incredibly hard to come by. Hopefully, as time progresses new business owners will begin to see profit growth. This can be tempting, especially if you have been on the bread line for so long. It is at this point you need to consider; how much should I pay myself? This questions is especially dictated by how much tax you’re a likely to pay on your own income. By providing you with our advice we aim to make your life easier when making this big decision. Let us know if this has helped you by commenting and sharing this article.
Paying Yourself from Profits
As a new business owner, it is difficult to know how much to pay yourself from your profits. When you see money flowing into your business, don’t always assume you can always take this out. As a business owner, you must first take into account possible outgoings such as taxes, payroll, fixed costs and overheads. All external outgoings, if not accounted for, will cause complications when figuring out your take home. By preparing your books and keeping track of all expenses and expenditures, the process of working out your take home pay will become clearer. Once all of your outgoings have been worked out against your profits you will be able to decide how much to pay yourself.
It is recommended that new business owners attempt to live a sensible existence early on in the company’s life. If not, you may be tempted to borrow more from the banks and run up the risk of rising credit card bills. This is something that will automatically put pressure on yourself and consequently your new business. In these early days, you must be focused on the end goal. Your business is an investment and shouldn’t be taken lightly.
Try to get an idea of other businesses in the same niche and size as yours. Establish what the directors are paying themselves and model yourself against that. You can find this out by speaking to people in the trade, although be cautious when asking someone’s wage directly. Keep in mind that they may also exaggerate this figure.
Investment and Growth
Money that is taken out of your business to pay yourself cannot be used as an investment to help growth. It’s also worth reminding yourself that you are likely to be taxed on the money that you take out, making the money you keep in your business much more valuable. This is because the money that remains in your business will either be untaxed or offset against tax.
If you have plans to grow the business in the future, then you should think about keeping as much money in the company as possible. The more money invested in the business the more likely it is that your company will grow. Big picture; with company growth comes greater profits and consequently an ability to pay yourself a bigger wage.
Pay Yourself Sensibly
That being said, no-one sets up their own business with the intention of not getting paid. So be reasonable with paying yourself what you need. Holding money back is likely to cause you financial problems. The key here is to pay yourself a comfortable amount. If you underpay yourself, you run the risk of causing unnecessary stress, which in turn will lead to poor business decisions. Ensure that you pay yourself regularly, whether that is weekly or monthly, it will help with the monitoring of cash flow and can prevent any organisational issues.
Over time, you will want to pay yourself more as your business grows. It’s worth factoring this in when writing your business plan; planned growth and how this correlates with your subsequent pay rise. This is also more preferable in the government’s perspective who look at sporadic cash withdrawals with suspicion. This could lead to a tax audit of your company.
Consider Legal Structure
How much you pay yourself can be limited by the nature of your business. Sole traders are usually exempt from specific rules and are free to pay themselves whenever and whatever they wish. This is because they are not accountable to shareholders or stockholders. Incorporated businesses on the other hand usually have a business owner on the payroll and should, therefore, be accounted for. We recommend contacting your accountant to find out the full ins and outs of your businesses legal structure. Be sure to leave a paper trail of all transactions as well as recording electronically in preparation for an impromptu visit from the tax office.
Once you have decided what salary to pay yourself, the next question you should be addressing is; what is the most tax efficient way of withdrawing money. Tax rates will vary depending on how your business is legally structured so here are some ideas to consider;
- Take a straight salary. As discussed previously this is the straightforward process, it’s easy to account for and is unlikely to cause any tax faux pars. It is however not always the most tax-efficient method.
- Balance your salary with dividend payments. If you own shares and stocks on your business, you can take out a minimum salary and pay the remainder in dividend payments. This can work out as much more tax efficient. Always make sure you check with the tax office first, just to ensure everything is above board.
- Combine your salary with an annual bonus. Explore this option with your accountant as it can be beneficial in certain circumstances.
Deductions, Expenses, and Benefits
Away from wages, running your own business has many great advantages and benefits such as medical insurance or pension contributions. Advantages such as reduced car expenses (business mileage) mortgage interest payments (if you work from home) or capital equipment expenditure (for office equipment). Take advantages of these benefits with the help of your accountant. They are incentivised to encourage business growth, so take advantage if them!
When Not To Pay Yourself
If your business has hit a rough patch, then it should be the owners who take the hit. You shouldn’t be paying yourself if your employees haven’t been paid. If you owe money, it is also wise to refrain from paying yourself as creditors are unlikely to be pleased if they find out.
Dividends – Shareholder Advice
Dividends are essentially payments made to the company shareholders from the profits of the company. If the company has not made a profit over a certain period, then it cannot pay a dividend. It is up to the directors to decide when to pay dividends to the companies’ shareholders. A dividend is essentially a reward payment to the shareholders for investing in the company.
Dividends are culpable to corporation tax and personal tax liability in the way of income tax. The corporation tax is calculated and paid to HM Revenue and Customs at the end of each financial year. It takes into account the overall profit of the company and the dividends that have been made over this period. It is, therefore, difficult to estimate exactly how much you should be paying your shareholders and how much of this will be taxed.
From April 2016, the national tax credit of 10% was abolished and replaced by a £5,000 tax-free dividend allowance. All dividends above the new limits will be taxed at;
7.5% – Basic Rate
32.5% – Higher Rate
38.1% – Additional Rate
All in all, paying yourself is a complexed, rocky road. If we could give one piece of advice it would be to keep modest. Sure the temptation might be to bank as much money as possible, you came into business for the Mercedes right? But still, in the early years, keep the costs down and your personal profit lower. Invest and encourage the growth. You will be able to reap the rewards once your business turns into a full-fledged money machine.
Article by Alexander