Your Director's Salary Needs a Complete Rethink

One thing I've noticed about small business owners in the UK is that they really struggle to know how much to pay themselves, especially as limited companies. It gets a little bit more confusing because you have things called dividends which you can pay yourself alongside your salary. First of all, I'm going to kick this video off by saying that hashtag I am not an accountant, and the advice which I'm about to give, if you are an accountant, kind of goes against the grain a lot. It's not necessarily going to be the best tax advice. So please, if you are an accountant, if you're into bookkeeping and finance, please do take what I'm about to say with a little bit of a pinch of salt, because how I'm going to approach this is more from a mindset perspective for the business owners as opposed to a practical, tactical accounting perspective. So first of all, I wanted to say something about why accountants give the advice that they do. So accountants, when they're speaking to business owners, will always suggest to use the most tax-efficient method of accounting and managing your money as they possibly can do. So what this means is in the UK we have something called the lower earnings threshold, which is around about £12,500 a year. So you can pay yourself as a salary, as a business owner, £1,000 a month and you won't have to pay any tax. You might have to make some small amount of National Insurance contributions. It's like, you know, a few hundred pounds at the end of the tax year. That's a very tax-efficient way of doing it. And then the idea is that if you then make a profit over and above that and initial £12,500 that you've paid yourself, you can then pay yourself in dividends. And it used to be years ago when I first started my business, there were all sorts of benefits for small business owners in terms of— years ago, £10,000 dividend allowance. You could pay yourself £10,000 worth of dividends without having to pay any tax, which is brilliant. So you could pay yourself that, that small amount of salary plus dividends. That's a nice starting income if you've just kicked your business off. However, the government have stripped away that benefit So I think it's now down to this year, it's either £1,000 or it will soon be £500. That's all your dividend allowances. There's no real benefit as such. Well, there kind of is and there isn't benefits to paying yourself in dividends. There's 2 taxes which you need to consider if you do pay yourself dividends. Obviously, if you've made profit and your profit is less than £50,000, you have to set aside 19% of that profit for corporation tax. So that's really important to remember. They've introduced a new tier recently which means that over above £250,000 worth of profit, which you may or may not fall into, you have to contribute 25% towards corporation tax. And there's this grey area in the middle which is between £50k and £250,000 profit where effectively you're taxed at 26.5% because it has to ratchet up the amount of tax you You pay between 19% and 25% in those 2 bands. Understanding how much corporation tax you've got to pay is a really important part of this calculation in terms of your overall salary. The second tax you've got to pay is the dividend tax. So that used to be 7.5%, it's now 12.5%. The government are doing everything they possibly can to balance out the benefits that you used to have as being a limited company director paying yourself a salary and dividends. They're trying to equalize it effectively with just going out and having an ordinary job. Kind of makes sense. They want to tax you. It goes into the coffers for the benefit of the country. Whether it's spent well or not, that's probably something, a topic for another video. So you have to consider first of all the corporation tax allowance, which you've got to set aside. Then also you've got the dividend tax as well, which you have to pay personally. Your business can pay that on your behalf. Again, there has to be an adjustment for that within your probably next year's payroll, for example. So you get a new payroll code which takes into consideration any extra dividend tax or any taxes, personal taxes, which you've had to pay. You can have those reduced from your salary. Through payroll, um, so that— or PAYE. So that works quite well. Now the accountant's view is that they want to save you as much tax as possible, so the most tax-efficient way of paying yourself would naturally be lower earnings threshold, £12,500 a year, and then anything extra you pay dividends, making sure that you'll say— if you were to look at something like Profit First by Mike Michalowicz, which is a fantastic book, you will then be setting aside money for VAT, money for corporation tax, money for PAYE and National Insurance contributions. You'll have a fun pot, you'll have a rainy day fund, so you'll have all these different funds set up. But ultimately the idea is that you want to be a bit prepared for the tax which you've got pay. I have a different view, and this is where I think a lot of people get very confused, because accountants have— you know, go and speak to your accountant and this is what they'll tell you: pay lower earnings threshold, pay dividends. All accountants will tell you to do that. It's the most tax-efficient way to do it. And this is where me and them differ, because I believe that as a business owner, you're worth more than £1,000 a month, okay? Quite frankly. And yes, you can pay yourself some extra dividends, etc., etc. But the challenge is most business owners don't understand how to calculate their dividends. So what happens is you get to the end of the year and you might have a bit of a surplus in your accounts, but then you do— the accountant does all these backward-looking calculations. They give you a huge great big corporation tax bill, which comes as a bit of a shock for most business owners. See, I see this all of the time, so this isn't something which I've made up. I bet you watching this, at some point you've probably had a shock tax bill that you've had to pay, whether it's corporation tax, personal tax, it doesn't matter what it is. You've had a shock tax. In fact, if you have, maybe pop it— don't put the amounts in there, you don't have to say that, but just put, yep, that's me, I've had a shock tax bill in the past which I wasn't expecting, which my accountant just dropped on me. I see that all the time. And for me, I find that irresponsible on the part of the accountants. Accounting shouldn't be backward-looking. It should be about forward planning, making sure that every month, every quarter, you're very clear on how much tax you owe and you've got the money set aside in those tax— those buckets, so that at the end of the year, when the accountant does his calculations and formalizes your books, you've already got the cash there to pay for those bills. Okay, no more surprise VAT bills, no more surprise corporation tax bills, no more surprise personal income tax bills which you've got to pay. So this is about being forward-thinking. This is where we start to get into the controversy, okay? My recommendation is that business owners should pay themselves their full-time equivalent salary. So for example, if you were a dog groomer and you own your business, and if you had to hire in another dog groomer and it would cost you, say, £2,000 a month, that's the salary that you should be putting through payroll. Now you will end up paying a little bit more tax over the course of a year, round about £20,000. It won't be too dissimilar really to what your corporation tax bill and put like a few hundred pounds in it. And I, I worked out with my account— my own accountant that I could probably pay myself up to about £30K, £33K before all of the different— the business taxes and my personal taxes started to kind of balance each other out. And all of a sudden doing it the dividend approach way started to become really a lot more beneficial when you start to hit that— start to hit that £30K mark. Yeah, you're going to pay more tax. Fine, but here are the benefits of it. If you pay yourself a salary and you, you, you or your accountant or bookkeeper run your payroll monthly, it means that one, you know exactly how much you can pay yourself, and two, you immediately get a report which says how much tax you need to set aside and how much National Insurance contributions and student loan deductions you need to set aside if you've got them. So you can put those aside each month. It teaches you to save your tax, and that is really beneficial as a business owner because it means you're prepared. So that's the first thing just to bear in mind. So if you're paying yourself £1,000 a month, at the moment, and your accountant will be telling you to do that, I can guarantee it. By the way, you don't have to listen to the advice your accountant gives you, but if you want to pay yourself more money from your business, you just need to instruct your accountant that this is what you want to do. They may push back, they may say this will mean you're going to pay more tax this year, and if you feel that this is a sensible way for you to manage your money within your business and pay yourself, just say, I hear you, I understand that, I know I'm going to pay a little bit more tax over the course of the year, but this means I'm not going to get as many surprises. So one, you can set aside your tax and pay it month month, okay? And that works really well. And then if you've got a direct debit set up to take your tax and National Insurance contributions, it's all very automated. You just need to make sure you set aside that money in a savings account and, and pay it regularly. The second benefit is that if you pay yourself a slightly higher salary, it does reduce your profit at the end of the year. But what it does do is it gives you a more realistic level of profit. Because if something happened to you, if you got ill or couldn't work, or actually just chose that you wanted to step away from your business, you're gonna have to hire somebody to replace you. And then all of a sudden, like, you're gonna see that profit disappear anyway because now you've got to hire somebody. I believe if you're paying yourself a majority salary and dividends, basic salary and dividends, it actually doesn't give a realistic, a true reflection of the profitability within the business. Because I see so many business owners who are like, yeah, I did $100K this year and I made $40 grand profit. And then I asked the question, well, was that before or after you got paid? And then they say, oh well, that was before I got paid, I just took all the rest as dividends. That business doesn't have any profit. And when you can't calculate your revenue, your gross profit, and your net profit especially accurately like that when it's, it's obfuscated by the fact that like you're over— artificially overinflating your profit. It doesn't give you a true reflection of the profitability of the business. And so if there are any problems, it's really hard to figure out where those problems are happening and why and what levers you've got to pull in order to create more profit, more revenue, and more profit. The other benefit is that at the end of the tax year, if you paid yourself a higher salary, well, it is going to reduce your profit, which means your corporation tax bill is going to be lower. Corporation tax typically tends to be the biggest lump That's a sum that most businesses pay out on an annual basis. And for 90% of businesses, I see this all the time, they get to the end of the year, they think, great, it's the end of the year, big relief, hand over the books to the accountant, bookkeeper runs things. Oh my God, we got this great big tax bill, this corporation tax bill we got to pay. And yes, you do get 8 or 10 months to pay that, to plan and pay that money back if you haven't saved for it, but it's a shock. It's much better if you've used a different mechanism so you've paid your tax slowly And regularly through PAYE and National Insurance contributions, and so that when it gets to the end of your financial year and your tax calculations come through for corporation tax, that's going to be smaller because it's reduced by the fact that you've been paying yourself regularly throughout the year. And again, so it's more about from a mindset perspective reducing that shock at the end of the year and having that big bill to worry about and pay for because it does cause an awful lot of stress. So for me, that's a much better way of doing it from a mindset perspective, and not least because it means if you're paying yourself a fair salary, it means you value yourself. You value yourself as an important employee within your business. You deserve to pay yourself a fair salary. So the implications of doing this, it probably means, uh, I mean, I, like I said, I went from paying the basic rate salary, which I did for years through my agency days and at the start of my coaching practice, had this conversation with my accountant. I said, look, I want to pay myself more. So I pay myself the equivalent of, I think it's about a £33K a year salary. It means that over the course of the year, I probably end up paying somewhere between about I think it's about £800 a year's extra tax on top of it. Everybody has to pay tax. My view is that if I'm worrying about a few hundred pounds here or there, there's more inherent problems within my business. It means I'm not earning enough money. If I, if I'm worried about a few hundred pounds worth of an extra tax bill, I'm not earning enough money in the first place and my business isn't profitable enough in the first place. So again, it just gives you that little early warning signal of when things aren't quite working out right, as opposed to paying salary and dividends. And I also know then that, well, I run my payroll, this is how much I get paid. Anything else I get over and above that in terms of dividends is a really nice Brucey bonus for me. A couple of things which you can do, again, to— through that, the method which I've talked about, paying yourself an actual fair salary, and if there is some profit left, obviously pay yourself some extra dividends as well, but pay yourself a fair salary. There's a couple of ways to mitigate some of those— the sort of tax, the efficient effective tax increase through that. There's something called, um, Small Employers Relief. So here's what I was talking about, the settings in Xero. Obviously there'll be equivalent settings in QuickBooks or FreshBooks or FreeAgent or whatever bookkeeping software you use. But the 2 things I want you to pay attention to are Small Employers Relief, which most people watching this video will— it will apply to. The second one is Employment Allowance, and this essentially gives you a £5,000 benefit on the first £5,000 worth of National Insurance contributions that you pay as an employer. There's a couple of caveats to that though. If it's just you, if you're a one-person business, you can't— as a company director, this doesn't apply. You can't tick that box, unfortunately. So you have to pay those first £5,000 worth of National Insurance contributions. This only applies if you've got basically more than one employee. So if there's 2 people, full-time, part-time, doesn't matter, you can tick that box. And provided there's National Insurance contributions being made by the business, you get that benefit of the first £5,000 worth of National Insurance contributions paid for. So that's quite a huge benefit if you do employ people, and it certainly closes the gap between paying yourself that basic rate salary, it just makes it much more tax efficient to do it this way. If you've got employees, tick that box, basically closes the gap down. So just ticking that one box creates an enormous amount of saving, and that closes the gap between my method of paying yourself a fair salary and the accountant's method, most tax efficient method, of paying yourself the basic rate salary plus dividends. Hopefully that kind of gives you a bit more understanding about sort of why you should pay yourself more than the basic rate of salary, the £12,500. Because you're basically— you're worth it. And if you had to replace yourself, you'd have to be paying that salary anyway. So it kind of makes sense. We all have to pay tax, but it does mean that you can then space— you know, you're paying smaller amounts of tax little and often over the course of a year rather than then getting this huge great big surprise corporation tax bill and other tax bills around that which come as a shock at the end of the year. It just means you can be more forward-thinking. You can set the money aside. You're much better prepared. Your accountant won't like it, but at the end of the day, it's your business. You get to choose how much you pay yourself and how to run your business. It's not, it's not about— there's no avoidance or, you know, it's not playing the game or anything like that. This is just about paying you what you're worth.