Being a sole trader, you are the boss of your own business. Sounds cool, right? But you cannot just take away all your business’ income every month.
Of course, there should be a balance between your personal finances and business funding needs.
Your business still requires resources to operate smoothly, comply with tax regulations, and expand if you want it to grow and provide you with more income.
In this regard, you should learn how to pay yourself properly as a sole trader. In this blog post, we will provide some tips and helpful guidelines. Continue reading to learn more!
UK Sole Traders: Paying Yourself Properly
One of the main aspects of managing your finances as a sole trader is paying yourself properly. But with so many options available, it can be tough to figure out the best way to do this.
That’s why we’ve put together this comprehensive guide to help you pay yourself properly and avoid any headaches come tax time.
Salary or Drawings: Which Payment Structure is Right for You?
The first decision you need to make when it comes to paying yourself is whether to do it through a salary or drawings. Both options have pros and cons, but the best choice will depend on you.
If you choose to pay yourself through a salary, you must register as an employer with HMRC and set up a PAYE scheme. This can be a bit of a hassle, but it offers some advantages.
For example, it can help you budget more effectively because you’ll know precisely how much you’re getting paid monthly.
On the other hand, taking drawings from your business’ profits can be an easier option. You can take out money whenever needed without worrying about setting up a PAYE scheme or following complex rules and regulations.
However, it’s important to note that taking drawings doesn’t provide the same level of protection as a salary. If your business runs into financial trouble, your personal finances could be at risk.
Sole Traders: How to Pay Yourself Through a Salary
If you’ve decided that paying yourself through a salary is the right option for you, here’s a step-by-step guide on how to do it:
Step 1: Register as an Employer with HMRC
Before you can set up a PAYE scheme, you’ll need to register as an employer with HMRC. This process is straightforward and can be done online via the HMRC website.
Step 2: Set Up a PAYE Scheme
Once you register as an employer, you need to set up a PAYE scheme. This involves choosing payroll software or outsourcing to a payroll provider, setting up a PAYE reference number, and deciding on a payment frequency.
This can be beneficial if you have several employees aside from yourself, but if you are the only one handling your business functions, this can be cumbersome and not worth undergoing.
Step 3: Calculate Your Salary
You’ll need to decide on a reasonable salary based on your business’ profits. This should take into account your personal tax allowances and any other possible income.
Step 4: Process Your Payroll
Now that you’ve got your PAYE scheme set up and your salary calculated, it’s time to process your payroll.
This involves running payroll software or working with your payroll provider to ensure you are paid your correct salary, and all the necessary tax and National Insurance contributions are deducted.
Step 5: Record Your Salaries
You must keep accurate records of all your business transactions, including salary payments. This will help you stay on top of your finances and bookkeeping and ensure you’re paying the correct amount of tax.
How to Pay Yourself Through Drawings?
If you assessed that it is difficult to set up the PAYE scheme and resort to drawings as your personal payment structure, follow these next steps:
Step 1: Calculate Your Profit
To determine how much you can afford to take in drawings, you’ll need to calculate your business’s profit. To do this, you’ll need to subtract your business expenses from your business income. The remaining amount is your profit.
Step 2: Decide on a Drawing Schedule
With drawings, you can take out money whenever you need it. However, a schedule ensures you’re not taking out more money than your business can afford.
Consider creating a budget and sticking to a regular drawing schedule.
Step 3: Record Your Drawings
Make sure to record all your drawings. This will be essential in maintaining the accurate accounting of your business transactions and proper payment of taxes.
Step 4: Set Aside Money for Taxes and Other Business Funds
Remember that as a sole trader, you’ll need to pay taxes on your profits. It’s important to set aside money from your before-tax income to cover your tax obligations.
In addition, it’s essential to have an emergency fund in case unexpected expenses arise or your business experiences a downturn. This will give you peace of mind and financial security during difficult times.
Finally, having funds for expanding your business is also an important factor to consider when paying yourself as a sole trader. If you have plans for expansion, you should set aside resources to materialise these wishes.
And while it can be tempting to withdraw the funds for personal use, it’s crucial to resist this temptation. This will allow you to invest in the growth of your business and increase your income in the long run.
Frequently Asked Questions
How can I pay taxes if I also have other income sources?
You must complete your self-assessment tax return yearly to report your income to HMRC. This includes not just your income as a sole trader but also any salary, dividends, or other income you have received as an individual.
It is important to keep accurate records of your income and expenses throughout the year to make this process easier.
Can I take money out of my business whenever I like?
If you choose to pay yourself through salary, then the answer is no, since salary is usually set up periodically, unless you take cash advances which might complicate your records and possibly defeat the purpose of your scheme.
However, if you choose to get drawing from the business, you can do so whenever you need it, but you should keep accurate records of any withdrawals.
It is important to note that any money you take from the business account will be subject to income tax and National Insurance contributions.
Can I change my payment structure from salary to drawings or vice versa?
Yes, you have the flexibility to change your payment structure from salary to drawings, or vice versa. However, it’s important to ensure you’re paying yourself properly and meeting your tax obligations.
There is no defined rule on properly paying yourself as a sole trader, especially if you are only a startup business owner. However, as you become more familiar with the process, you can fine-tune your payment structure and find what works best for you and your business.
Check out Sterlinx Global for more professional advice.