Are you paying yourself wrong?

31st January 2018

Politicians and marketers like talking to people as if they fall into neat categories.

They may address “women”, “mothers” or “parents”. Sometimes they talk to members of a particular ethnic group, or “working people”. Sometimes it’s “Scots” or “People living in Wales”.
Their underlying assumption is that all those people have certain interests or traits in common, and can be spoken to as if they were one group.
But the reality today is that people have multiple – and often competing – identities.
Mothers can also be members of a particular ethnic group… and / or “working people”…. And / or “Scots”. So can fathers – or just men – for that matter….!
And before I tie myself into too many knots here, the examples are endless. We all wear different hats in our personal lives.
The same is true for us as the heads of our companies, even though we mostly don’t think of it like that.
Most of us usually refer to ourselves as business owners or founders.
But we’re usually also a director.
And… we’re also an employee of our company.
It’s important to keep that in mind, because all three roles have different responsibilities and a different relationship to the business.
They are also paid in different ways – which is what I really want to talk to you about today.
You see, owners receive dividends – That is, a share in the company’s profits.
Directors receive directors’ fees.
And employees receive salaries through payroll, just like any other staff member.
So which role do you reward? How do you pay yourself?

You might imagine that it doesn’t make much difference – money is money… -- but it does.
Over the last few weeks, we’ve been talking about why it’s important to develop a deeper understanding of the tax implications of your business decisions. The way you pay yourself is a case in point.
It will impact both the tax you pay and the tax your company pays.
This can be complex so I won’t get too technical, but here’s one example.
If you are paying yourself dividends, this is taxed as investment income rather than earned income and so you may avoid both employers' and employees' national insurance on that income. 
But if you pay yourself a salary, this is earned income and you do pay employers' and employees' national insurance (potentially up to 25.8% combined), so this is potentially far less tax-efficient.
On the other hand – and this is where it gets complicated -  if you pay yourself a salary it will have the positive effect of reducing your company’s corporation tax liability because your overhead costs are higher and therefore your profit is lower ….
In short, there is much to consider, and many combinations of all three methods of payment are possible (you do not necessarily have to pick one or the other).
You must not take it for granted that you should be paid through payroll – as so many business owners I encounter do -- without investigating the alternatives, which may be far better.
This is a basic issue which your accountant should have in hand, and be constantly revisiting, to make sure that the arrangements are still appropriate.
The bottom line is this. Tax – as I wrote a few weeks ago – is an expense like any other, which you can manage and reduce (in legal ways) if cutting your outgoings and increasing profits is a priority for your business.
But to do that, you need some basic understanding both of how tax works and how it applies to your business.
If you’d like to do that in partnership with us, just get in touch and let’s talk about how we can help.

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