A question we hear often from small business owners is “How much should I pay myself?” Firstly, there’s no point in underpaying yourself, personal money issues are a big cause of stress, and if you’re stressed then you won’t make good business decisions. So it makes good business sense to pay yourself enough money to live comfortably without worrying. Take out what you need, but avoid causing problems for your business.
Ensure that you pay yourself regularly, don’t just dip into your business bank account as and when you need to, if you take out big sums of money at irregular times, it may raise eyebrows at the tax office (HMRC). Also, make sure the funds you take out can be shown as “reasonable compensation”, which can be defined using these points:
– How much would a similar business pay for similar services to the ones you personally provide to your business?
– What do recruitment ads and agencies offer to pay for someone in your position?
– Are your wages equal to your duties and are those duties being performed?
– Do your wages seem reasonable when you take into account of your level of responsibility and the amount of business you handle?
– Is your pay directly related to the amount of time you spend working?
– Does your pay seem reasonable when compared with your employees’ wages?
– Take a look at your government’s tax websites for further guidelines.
Now you’ve decided how much is a fair salary for you, what’s the best way to withdraw that money from your business while remaining as tax efficient as possible? Tax rates and allowances will also vary depending on how your business is legally structured. Here are some ideas to consider:
- Take a straight salary. It’s simple, easy to manage and account for, and is unlikely to raise any eyebrows. It’s not always the most tax-efficient option, though.
- Balance salary with dividend payments. If, as the business owner, you also own stock or shares in your company, you could take a minimal salary and then pay the remainder out of dividend payments. This can be more tax efficient (since dividends are usually taxed less than salary). Make sure you check the legality with your tax office first.
- Take payment in stock or stock options. This can be a useful way of paying yourself in a tax-efficient manner.
- Take a combination of salary plus annual bonus. This arrangement isn’t just the preserve of the banking industry and it can be tax efficient in certain circumstances.
Leaving aside wages, there are some great financial benefits to running your own business, here are some examples of expenses that can be offset against the tax your company pays:
– Car expenses (business mileage of your car)
– Mortgage interest payments (if you work from your home)
– Capital equipment expenditure (such as new computers).
– You’re not usually allowed to claim expenses in the “personal, living or family expense” category. But you can claim for the business use portion of an item.
It’s also very important to keep mind when not to pay yourself!! If your business is going through a tough time financially, it’s usually not a good idea to take any money out of your business for personal use. You should avoid taking any money if your employees haven’t been paid. It looks bad, and would seriously affect their morale if you did. When you owe a lot of money it’s also wise to refrain from paying yourself a large amount. Creditors are unlikely to be impressed if you’re still taking home a large pay packet while their invoices or loans remain unpaid.
Ultimately the amount you pay yourself will depend on the success of your business. The more money your business brings in, the higher the salary you could reasonably be expected to draw from it.