small business owner salaryHere’s the golden question that mankind has been asking themselves ever since man first stepped out of their cave and decided to set up a designer loincloth fashion retailer; ‘How much do I pay myself for running a business?’.

That’s a great question and I’m glad you asked it, although what you’re actually asking here is two questions:

  1. How much do I pay myself?
  2. What is the best way to pay myself?

A lot of business owners will make the mistake of simply taking their profits as their wages; after-all, once you’ve deducted for tax, expenses, employee wages (if you have any), and any stock you require for your business then the rest makes up your wages right? No. Or at least not strictly speaking any way.

1. How much do I pay myself?

In theory, you can pay yourself as little or as much as you want to; it’s your business, you’re the boss, and you get to decide. Just because you can, however, doesn’t mean you should (this goes for both directions). Paying yourself too much can jeopardise your business and cause real problems in the long run, but paying yourself too little can create issues in your personal life. You need to find the right balance.

  • Figure out your self-worth. Do some research into similar companies; I don’t just mean similar industries, but similar sizes and similar locations too. Find out how much other small business owners are paying themselves and why.

    Similarly, you could find out how much your position would be worth if you were an employee of a larger business in the same industry as yours. This can easily done through Google/Bing or through job-advertising agencies.

    This is a great way to get an idea of how much your work should be worth and gives you a good basis on how much you should be taking from your business for yourself.

  • What about tax? As you can imagine, the taxman is going to want to go scrounging through your pockets to take every penny they can get away with. It’s up to you to put measurements in place to help maximize your personal profit and minimalize the amount HMRC can take.

    It may sound strange, but it’s actually better to pay yourself less as a direct wage. This can help lower (or completely avoid) your taxes. Everyone gets £11,500 as a tax free personal allowance; this money isn’t taxed but you will still pay NI on it. If you don’t want to pay NI, you’ll need to go down to £8,060 per year, roughly £871 per month.

    I know that doesn’t sound like much (because it isn’t), but it’s the not the whole of your pay. I’ll go into more detail about how you receive more in question 2.

  • Pay yourself periodically. Keeping a regular payment to yourself is extremely important to maintaining your business’ funds. It doesn’t matter if it’s weekly, fortnightly, monthly, or yearly (although I do recommend against yearly). As long as you’re paying yourself on a regular basis then both your business and personal funds will have structure.

    It’s also not good practice so filter business funds for your personal use. You need to imagine yourself as two people, the business owner and the employee. The employee represents your personal funding and needs; as an employee you wouldn’t siphon funds from your boss to fund your weekend away in Vegas, so why would you for your own business?

    Keep your personal and business funds separate. Even if you don’t have a business bank account you should have a separate account for your business profits. It’s good practice and it will make your time dealing with HMRC significantly easier.

2. What is the best way to pay myself?

If you’re a Sole Trader, the only way you can pay yourself is out of your profit and you’ll have to register this through HMRC’s Self Assessment form.

As we mentioned earlier, if you don’t want to pay NI or tax, you’ll have to pay yourself £8,060 or less a year (£671.66 per month). This doesn’t sound like very much it isn’t the entirety of your pay.

If you’re a Limited Company, you can pay dividends out of your profit to your shareholders. If you only put yourself down as a shareholder, this will mean you get 100% of the dividends. This might sound like a round-about way to pay yourself, but you have to give up less of your profits for tax in return.

You will also have to register as an employer with HMRC if anyone in your business (including yourself) is earning over £112 a week, even if you’re the only employee.

Let’s look at the numbers:

  • You receive a tax free personal allowance of £11,500, but to avoid NI you can only receive £8,060.

  • The first £5,000 you receive in dividends are tax free. After that you pay 7.5% up to £33,500.

  • In total, this means you receive £16,000 tax free, or £13,060 if you don’t want to pay NI.

Already we’re seeing the benefits of paying yourself through dividends rather than a Self-Assessment or PAYE. Let’s take a look at two examples, one where you pay through dividends and the other where you’re paid straight from your profit.

Dividends Salary
Company Profit £30,000 £30,000
Total Tax and NI Free Allowance £13,060 £8,060
Remaining Profit £16,940 £21,940
Basic Tax Rate 7.5% 20%
Amount Taxed £1,270.50 £4,388.00
Total Profit £28,729.50 £25,612.00

That’s over £3,000 difference just by paying yourself in dividends. Easily worth the extra effort.

The higher tax limit for dividends is slightly lower than income tax. Dividends higher tax limit is £33,501 – £150,000 taxed at 32.5%, whereas income tax is £45,001 – £150,000 taxed at 40%.

Let’s take a quick look at how those numbers go together when over both higher thresholds and in between the two thresholds.

Both Higher Limit

Dividends Salary
Company Profit £50,000 £50,000
Total Tax and NI Free Allowance £13,060 £8,060
Remaining Profit £36,940 £41,940
Basic Tax Rate 32.5% 40%
Amount Taxed £12,005.50 £16,776.00
Total Profit £37,994.50 £33,224.00

In Between the Thresholds

Dividends (lower) Salary (lower) Dividends (higher) Salary (higher)
Company Profit £35,000 £35,000 £45,000 £45,000
Total Tax and NI Free Allowance £13,060 £8,060 £13,060 £8,060
Remaining Profit £21,940 £26,940 £31,940 £36,940
Basic Tax Rate 32.5% 20% 32.5% 20%
Amount Taxed £7,130.50 £5,388.00 £10,380.50 £7,388.00
Total Profit £27,869.50 £29,612.00 £34,619.50 £37,612.00

As we can see from these tables, the only time you should pay yourself directly from your profit and not dividends is when you’re total business profit is between £33,501 (the lowest possible amount of the higher dividends threshold) and £45,000 (the highest possible amount of the lower income threshold).

I know this all seems complicated, and we haven’t even gone into how you determine what your overall profit is yet! This is why most people will hire an online accountant to work this out for them. Your Company may be earning £40,000, but that’s before your tax, expenses, and everything else that has to come out. You might actually have a total profit in the lower tax region.

Zooconomics online accountants are here to advise you on your finances and are able to figure out quite quickly whether it’s a better option for you to pay yourself through your profit or dividends. They’re also available to work out your Corporation tax, expenses, and any other financial task you need help with.

For more information, call 0800 0460 560