Self-employment offers a myriad of benefits compared to traditional options: flexibility, entrepreneurship, and freedom, to name a few. Of course, owning a small business is a labour of love—but it can also provide substantial profits while you invest time into what you’re passionate about.
While your small business brings in money, you also need to make something to cover your expenses, from groceries to your mortgage. As the owner and operator of your business, you are tasked with paying yourself as with any of your other employees.
There is more than one way to pay yourself as a small business owner. 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 in this regard is crucial both for your business and your needs as a self-employed individual.
How To Pay Yourself As A Small Business Owner
Self-employed small business owners traditionally have two popular routes: functioning as a sole trader, wherein your business income is considered personal income, operating as a partnership or limited company.
In the first method, your income is straightforward and comes in what is considered a “business drawing.” These business drawings are taxed at the same rate as your personal income would be, and are considered, indeed, personal income.
When operating a business as a partnership or limited company, however, you can pay yourself via a salary as well as dividends that are dispersed to all shareholders.
The best method to pay yourself depends wholly on what type of business you run–and the classification of such.
Paying Yourself As A Sole Trader
Operating as a sole trader is the most straightforward and flexible way to pay yourself as a small business owner. Establishing yourself 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
If any of them sound like you, but you aren’t ready to enter a partnership or limited corporation, then you should establish yourself as a sole trader.
As a sole trader, all of your business income is considered your personal income—there is no separation between yourself and your business, from a legal perspective. This makes tax payments relatively straightforward, as you’ll only need to inform HMRC that you pay tax through Self Assessment. You’ll need to file a tax return for yourself each year.
When it comes time for taxes, you’ll owe a bill on the money you made in profit as your income. Again, as a sole trader, this is the same as the total income for the business.
Pay Yourself a Salary
This is a more common method for small and medium business owners to pay themselves, especially if the business is paying taxes as a corporation or partnership separate from the individual. More or less, you pay yourself just like any other employee: You register yourself as an employer, and you submit Income Tax and National Insurance from your own salary. Your business then classifies your salary as labour costs when it comes time for corporate taxes.
One stipulation of paying yourself a salary versus filing as self-employed is that you must pay yourself a comparable salary to someone else performing your duties in a similar capacity within your industry. This can stretch your business thin when you’re not performing well and cause a loss. It also means that you may not be able to liquidate your equity as quickly or easily as in a sole proprietorship using the owners’ draw method.
When it’s time for taxes, your personal and business taxes will be separate. You pay your personal taxes according to your salary as well as any dividends. Then your business files its taxes as a separate entity.
Even though you pay yourself a salary and must contribute to National Insurance, you are still considered as a company Director. HMRC can collect your National Insurance in two different ways: once a year or every month. To contribute every month, you must select the alternative calculation method in your payroll software. It’s up to you to decide which calculation method is best for you.