What is the Most Tax Efficient Way to Pay Myself as a Business Owner?
Running your own business means being in complete control of every aspect of your workplace, including your finances. When you’re just starting out, one of the biggest challenges you’ll face is how to pay yourself. After all, you’ve worked very hard for the day-to-day running of your business, and it’s just right that you get a fair wage for your efforts.
There are a few avenues to take when paying yourself as a business owner. Your final decision will largely depend on whether you’ve registered your business as a sole trader or a limited company.
Sole Trader vs. Limited Company
If you classify as a sole trader, then all business profit is yours, and all of it is taxable. This means you are personally liable for your tax bills, so you must be diligent in documenting all of your transactions. Registering as a sole trader means that if you miss tax deadlines or don’t follow tax regulations, Her Majesty’s Revenue and Customs (HMRC) will come for your personal assets.
Tax experts advise sole traders to open a tax savings bank account that will hold 25% of your income. This amount should cover the costs of filing a self-assessment bill at the end of the tax year.
If you are registered as a limited company, the tax process is entirely different because you are an employee. Your personal assets are completely removed from the business, and your salary will be paid through business payroll. Many small business owners and consultants choose to register as a limited company because it’s the most tax-efficient way to get paid.
Filing Taxes as a Limited Company
If your small business is registered as a limited company, you pay salaries to yourself and all your employees under the Pay As You Earn (PAYE) system. This is a process that allows all workers to pay income tax and National Insurance.
Through PAYE, your tax is dependent on your salary. Crucial amounts for the 2021/22 tax season are as follows:
£6,240 per year (£120 per week) – The minimum amount to remain entitled to future benefit and pensions.
£9,568 (£184 per week) – This is the National Insurance primary threshold, so those who make at least this amount are eligible for insurance contributions.
£12,570 – Employees who make up to this amount are free from income tax obligations, though they still need to pay a small amount for National Insurance contributions
Between £12,570 and £50,270 – The yearly tax rate is 20%.
Between £50,270 and £150,000 – The yearly tax rate is 40%.
Over £150,000 – The yearly tax rate is 45%.
Salaries are a deductible business expense, so they reduce the corporation tax due every year. Other tax-efficient payment methods include:
Dividends – Any profit made after corporation tax can be distributed to business shareholders through dividend payments. In 2021/22, dividends below £2,000 are tax-free. And if you combine that with your allowable Personal Allowance (£12,570), any income up to £14,570 is tax-free.
Dividends between £12,570 and £50,270 – 7.5% tax rate
Dividends between £50,270 and £150,000 – 32.5% tax rate
Dividends over £150,000 – 38.1% tax rate
Pension contributions – Limited companies can also pay contributions to employees’ pension, up to £40,000 per tax year.
Business owners with registered limited companies have significant control when it comes to corporation tax. A combination of salary, dividends, and pension contributions will make your business highly tax-efficient in the right circumstances. Unfortunately, juggling all these assets and values can make any small business owner confused. Thankfully, an expert business accountant will help ensure you have the correct financial structure in place for maximum efficiency.
1to1 Accountants offers a wide variety of accountancy services in London. If you’re looking for an accountant for personal tax affairs, or if you are a small business owner struggling with self-assessment tax, our experts are here to help. Schedule a free consultation with us today!