Most self-employed individuals and small business owners struggle to figure out how much they should be getting paid, especially when they’re just starting out. Here’s how to determine what a fair wage looks like, and what you need to know about paying yourself.
When you start your own business, it can be difficult to know how you should be getting paid, particularly if you’re not making a lot of money. How do you set your salary? And how do deductions, expenses and taxes impact how much you earn as a small business owner?
- Don’t pay yourself too little
The first rule of getting paid from your small business or as a sole trader is that you should always pay yourself at least enough to live on – and with some degree of comfort. How you choose to pay that amount – whether as salary or as a combination of salary and dividends – is a different story.
- Don’t pay yourself too much
On the other hand, it can be tempting to treat all the money that comes in as your own – but it isn’t. First, you’ll have tax and national insurance obligations. You may also have to pay a number of expenses such as suppliers’ bills and salaries to contractors and staff, as well as rent and utility bills.
The key is to separate profit from revenue – but not all profit is money in your pocket. If you take all the money out of the business, you’ll have nothing left to invest for future growth. Even if you’re self employed, try to separate your business bank account and personal bank account and always leave at least a little in the business account.
- Understand deductions
Deductions are payments that need to be taken out of an employee’s salary and, as a small business owner, they’re your responsibility – not your employee’s. Common deductions include tax, national insurance, student loans and some other statutory payments. As a small business owner you need to make sure you’re complying with your obligations.
Tools like online accounting software can help you keep track of these deductions but if you’re in doubt about your salary and tax obligations, ask your accountant for advice. Speaking of which…
- Make tax work for you
One of the benefits of being a small business owner is that you can make tax work to your advantage. That’s because you may be able to structure any earnings to benefit from the 20 per cent tax on small business profits, rather than having to pay for everything as salary, which will be taxed at the standard income tax rates. To do so, you should think about getting paid a reasonable salary, topping it up with dividend payments.
If you choose to take this path, be aware that HMRC hands out severe penalties for getting it wrong. So you should always check with your accountant first.
- Know which small business expenses you can claim
Another benefit of being a business owner or self employed and getting paid is that you can deduct many of the expenses your small business incurs. These include some travel and office expenses, as well as some clothing and entertainment. In other words, the cost of paying for these comes from your pre-tax earnings, or profit, rather than post-tax earnings, or salary. You can read our guide to self-employed expenses here.
- Be consistent
One of the errors many small business owners and self-employed individuals make is that they don’t draw a regular salary or pay for expenses when they’re incurred. Instead, they take money out of the business only when they have to. But failing to make regular payments, and then taking out a large amount, is likely to attract the attention of HMRC. If you really don’t need a salary, there are more tax-effective options – such as getting paid in shares, paying a bonus or making a formal agreement to defer payment at a later date. Again, if you’re considering any of these options, you should speak to your accountant first.
- Take advantage of tax credits
If you’re self employed or running a small business and you’re struggling to raise enough to pay yourself a salary, you’re not alone. That’s why the government has a system of tax credits for small businesses. These offer some limited income support, by comparing your income to that of employed people working in similar fields.
Knowing how much to pay yourself, and what expenses you can claim, are some of the greyest areas for small business owners. But by taking advantage of the tools available and relying on the advice of your accountant, you can make sure you get the balance right.
To see how online accounting software can help you manage your small business payments and expenses, sign up for a free trial with QuickBooks.