Attention all business owners: how should you pay yourself?
Setting up a business isn’t the easiest task, but you’ve got it under control. You’ve got the right premises, hired the right staff, set up your IT infrastructure, and you’ve already got a few clients lined up. Soon, you’ll be making mountains of cash, just like you planned. But wait, how do you actually pay yourself?
When it comes to getting paid as a business owner, you have two options: take a wage and use the PAYE system or opt to receive dividends. Each has its pros and cons so it’s up to you to decide which is the best option for you.
If you want to receive a wage from your business, you must class yourself as an employee and enrol on your business’s PAYE scheme. You’ll likely be the company director. The benefit of getting paid this way means you can set your own salary as high as you like, within the means of your business. However, the downsides are you’ll likely pay a lot of income tax and national insurance payments, making the process very tax-inefficient.
You’ll have to pay two lots of national insurance contributions – for employers and employees, which together is more than double the prevailing income tax rate (20%). It may seem ideal on the surface – after all, you’ll be able to have a secure income every month which is the perfect peace of mind for your personal life.
But there are far better ways to get paid without handing over such huge amounts of your earnings to HMRC.
Dividends are another way you can get your earning from your business. They’re paid from after-tax earnings to shareholders and have many benefits above taking out a salary. These include:
- You don’t pay National Insurance Contributions on dividends.
- You can decide when you want to take dividends to protect your business bottom line.
- There is a tax-free dividend allowance which differs according to your tax band.
However, there are downsides too:
- Dividends are only payable from post-tax profits. If you don’t turn a profit yet but need payment, you’ll have to do this via a salary.
- All shareholders in the same share class must receive the same level of dividend unless there is a prior written agreement.
So if you’re looking for the simplest route, this might not be it. If you just want to put food on your family’s table, maybe consider an actual salary. Or why not a mix of the two?
Why not have the best of both worlds and pay yourself a salary while also receiving dividends? As of 2019/20, the personal tax allowance has increased to £12,500 and the basic rate threshold has reached £50,000. Any dividend above £2,000 will be taxed in the following ways:
- No tax payments if you have unused personal allowance which covers your dividend
- Dividends in the basic rate up to £50,000 are taxed 7.5%
- Anything above the basic rate is taxed at 32.5%
- Dividends falling within the additional rate band are taxed 38.1%
Some people take a low salary and a higher dividend because it works out as the most tax-efficient method of payment. They might pay themselves a salary just below the tax threshold, allowing them to take home as much tax-free cash as possible. It’s a sort of safety net should the worst happen. There’s nothing illegal about it either.
Relying on either a salary or dividends alone might not yield you the best results from your hard work. A combination of both methods of payment can help you earn money in the most efficient and reliable way. At the end of the day, you just want to run a successful company. So after all that hard work, reward yourself in the best way possible.
Knowing what to do when it comes to the big decisions can be stressful. Toughing it out alone might only make the problem worse. Big Hand helps ease the pressure by providing world-class business advice and tax services to our clients. All you need to do is call us on 0161 327 2911.