Many business owners do not know how much they should be paying themselves. Image courtesy of: David Playford/sxc.hu
When someone is running their own business and eventually the business is generating enough money for the owner to be able to draw a salary, a dilemma appears. How much should I pay myself? Am I paying myself too much or too little? Unfortunately, there are no right or wrong answers to these questions, says Deepaman Prabhakar of TaxClaim Accountants.
In the UK, there are two ways to take money out of your business, depending on if you are running your business as
‘limited’ company and withdrawing money from your profits, or if you are running as a
sole trader. These are salary and dividends. There are two main factors to consider.
How much am I worth?
The annual salary that you can achieve by working for someone else should be your starting point. For example, if you would be paid £35,000 per annum for someone else, and in your own business you are only able to take £20,000 per annum then it’s not really worth putting in all the hard graft of running your own business. But if you can make at least £30,000 and it is likely that it will go up as the business grows, then you should be fine. You may however need to accept that sometimes entrepreneurs can't afford to pay themselves a market-based wage, especially during their startup years.
If the company profits allow, you should definitely pay yourself the market rate; it enables you to look at your company from an
investor's perspective. There is no reason why you can’t take more money, if the company profits allow this. It could increase by five percent, 10 percent, 25 percent or even more. It helps you better understand the value of your own time.
Small business owners can arrive at a fairly good estimate of what their salary should be, by doing some research and comparing the salaries of similar designations within similar trades, and
talking to their accountants, who probably do work for other small business owners and can provide a general overview of what they're seeing in the market place.
What you cannot do is pay yourself a salary or dividends based on your needs. It is crucial to the financial viability of your company in the long term to make these sorts of decisions solely on what the company can afford, not on what you need.
Tax efficient ways to take the money
In a limited company, the usual approach is to take a salary to use up your personal allowance without any liability to income tax. For example this year the personal allowance is £8105 p.a. or £675.42 per month. This amount will reduce the company profit and the corporate tax bill. The dividend is taken from profit after tax and the dividends must not exceed the profit after tax figure unless the company has got reserves from previous years. However, if the business is struggling it would be advisable to draw a salary instead of dividends as dividends can only be paid out of available profit.
As a company owner it is possible that you would have invested money in the business at the start. This means that your ‘director loan account’ will be in credit. If this is the case, you can take money from the director loan account. You don't need to pay yourself the same salary every month. Indeed, you can charge your
profit & loss account by the same amount every month, but instead of paying yourself cash on pay day, you credit the director's loan account if cash is not available. Then you could take the money from the director loan account when the cash is available. The additional benefit of this is that you don’t lose your annual free allowance as well.
On the assumption that business is making enough profits, the other way to take money out of the business is by giving some shares to family members and distributing dividends, up to the limit where they don’t need to pay any additional personal tax. Family members who work for the company can be paid like any other employee. If your teenager works part time, you can pay hourly wages or a standard market rate.
Tax-deductible employee benefits can increase your annual pay. These can include health, dental or life insurance, paid holidays and sick leave.
All these options will vary from person to person based on personal circumstances. You should always check with your accountant what the best option is for you personally.
Deepaman Prabhakar is a highly qualified tax and financial advisor, with wide ranging experience across a diverse range of industries. He has specialised in working with small and medium–sized businesses.
He is a qualified Chartered Management Accountant, and is a member of the Chartered Institute of Management Accountants (CIMA,) UK. He works extensively in the areas of company accounts; tax returns; self-assessments; partnership tax issues; and tax investigation.