Payroll
Aug 6, 2023

How to pay yourself a salary as a Small Business Owner in the UK in 2024

Becoming an entrepreneur offers many benefits compared to traditional options, including flexibility, entrepreneurship, and freedom.

Of course, owning a small business is riskier, but it can also provide substantial profits compared to a standard 9-to-5 employment, especially if you know how to optimise your earnings.

The options reviewed below vary in tax procedure and what your year-end payment routine will look like and should be reviewed with an expert. Making the right choice is crucial for your business and your personal needs.

What are my options as a Small Business Owner

Small business owners traditionally have two popular routes:

  • Being a sole trader, wherein your business income is considered personal income: Your income is straightforward and comes in what is regarded as a“business drawing” You pay tax on these drawings via a self-assessment tax return.
  • Operating through a partnership or limited company: You can pay yourself via salary and dividends dispersed to all shareholders.

The best payment method depends wholly on what type of business you run–and the classification of such.

If you are a sole trader

Operating as a sole trader is very straightforward. Establishing as a sole trader is a must if you meet any of the below criteria:

  • Your self-employed income for the previous tax year exceeded £1,000
  • You need to prove your self-employment status to participate in benefit programs
  • You voluntarily would like to make Class 2 National Insurance payments to assist with benefit qualifications

As a sole trader, all of your revenue generated is considered your personal income—there is no separation between you as a person and your business. This makes tax payments relatively straightforward, as you’ll only need to inform HMRC that you pay tax through self-assessment and file a self-assessment tax return each year.

If you trade through a limited company or partnership

Trading through a corporation requires more administrative work but might pay off more. You’ll need to run payroll to calculate statutory deductions, such as tax, National Insurance, student loans, and benefit-in-kind.

Salary

In order to do this, the company must be registered with HMRC.

You must use the HMRC basic tool or payroll software like Moonworkers to deduce tax and national insurance contributions on your salary and submit your complete payment submission (FPS).

Many directors draw a salary below the yearly personal allowance to reduce tax.  

From 2024 to 2025,  the personal allowance threshold is £12,570. This means that, provided you have no other relevant income within the tax year, you can draw a salary up to this amount without the need to pay income tax.

Above the allowance, the amount of tax you will pay depends on the specific salary range within which your earnings fall.

If you pay yourself solely in salary, you would pay income tax as follows:

  • First £12,570 at 0%
  • Between £12,571 and £50,270 at 20%
  • Between £50,271 and £125,140 at 40%
  • Over £125,140 at 45%.

Notice that HMRC has introduced a PA reducer for earnings over £100,000. For every £2 earned over £100,000 each year, you would lose £1 worth of the £12,570 tax-free personal allowance.

Different rates and thresholds will apply to you if you live in Scotland.

Finally, it is important to remember that HMRC has simplified the above numbers to make them accessible. In fact, tax deductions are calculated using the exact percentage method, introducing specific rounding rules and formulas when salary is paid more frequently than annually.

Dividends

If the company makes a profit, then shareholders can receive dividends. All shareholders must proportionally receive the same amount of dividends.

HMRC introduced a nil rate of taxation applied to the first £1,000 per annum.

After that, dividends will be taxed by bands.

  • Basic Rate: 8.75%
  • Higher Rate: 33.75%
  • Additional Rate: 39.35%

However, the tax includes all your earnings subject to class 1A NI, not just dividends. For example, if you had received income up to the higher rate tax threshold and then paid yourself a £5,000 dividend, the first £1000 would be taxed at 0%, and the remaining £4,000 would be subject to the higher rate of 33.75%.

You can find additional details on the UK government website.

How to set up as a sole trader and prepare your self-assessment tax return in 2024?

Read more

Which approach Is right for me?

Weighing these options is not something to take lightly, but your accountant can help you break down your choices and select the one that makes the most sense for your situation.

Some things to consider:

  • The stage of your business
  • Your business type (sole trader, partnership, limited corp, etc.)
  • Your tax situation

Your business type is a major limiting factor, as many types of businesses are explicitly required or excluded from using certain self-payments.

Pros and cons of being a sole trader

Pros

  • Taxes are paid annually, allowing you to invest and budget as you see fit.
  • Money can be withdrawn as needed, making money available to you as personal funds in a pinch or allowing you to keep more money in your business to assist in growth.

Cons

  • Budgeting can be tricky due to irregular withdrawals and no tax withholding.
  • You may pay more taxes depending on your situation since everything will be taxed personally.

Pros and cons of trading through a company

Pros

  • Budgeting is more straightforward, as your salary is a regular, recurring business expense you can count on.
  • Taxable income is typically lower, given that your salary is taxed at a personal rate and deducted as a business expense on corporate income tax.

Cons

  • Limited access to your money, including equity you have in the business.
  • An inflexible fund payout can lead to business drains as you must pay yourself regardless of whether the business is doing well or poorly.

Step-by-step process

1. Decide on a reasonable salary

The first step in paying yourself a salary as a small business owner is to decide on a reasonable amount. This should be based on your business’s financial situation and personal financial needs. You should also consider the industry standards for salaries in your field.

2. Determine your business structure

The way you pay yourself will depend on the structure of your business. If you are a sole trader, you will be taxed on business profits. If you have a limited company, you can choose to pay yourself a salary or dividends. If you have employees, you will also need to register as an employer with HM Revenue and Customs (HMRC).

3. Understand your tax responsibilities

As a small business owner, you will be responsible for paying income tax and national insurance contributions to your salary. You must also pay the employer’s National Insurance contributions if you have a limited company. Register for self-assessment with HMRC and file a tax return each year. You may want to consider hiring an accountant to help you with this.

4. Choose a payroll system

You must choose a payroll system to pay yourself a salary. This can be a manual system or a software system. You must keep accurate records of your salary payments and any tax and National Insurance contributions deducted from your salary.

5. Set up a bank account

You must set up a separate bank account for your business to pay yourself a salary. This will make it easier to keep track of your business finances and ensure that you pay yourself a salary consistently and reliably.

6. Pay yourself regularly

Setting up a schedule is an excellent idea to ensure that you are paying yourself a salary regularly. Depending on your needs, this can be weekly, biweekly, or monthly. Ensure that you are paying yourself a reasonable amount and keeping accurate records of your payments.

Takeaway

The two main methods of paying yourself as a small business owner, whether by salary and dividends or as a sole trader, have different benefits and disadvantages to consider. When deciding which method is best for you and your small business, it’s important to consult with your accountant or other tax professional. Small business taxes don’t have to be complicated, but your decision should be informed to provide the best possible results for you and your business.

Give us a shot.

Choose Moonworkers online payroll services for professional, reliable, and knowledgeable service.
We have been using Moonworkers for quite some time and compared to other software in the market, we found it very simple to use and excellent. Moreover, the customer service is great.
Shabir D.
Euro-accounting

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