So, you’ve decided to make the big leap and start your own business. Congratulations.
There’s obviously lots to consider and do, but one of the first questions you should ask is how you are going to pay yourself. And how much?
The answer is dependent on certain decisions you make about your business.
One of the most important decisions to make concerns the type of business you’re setting up.
Are you going to be a sole trader, in a partnership or are you going to set up a limited liability company?
This decision will have implications about how you can pay yourself, as well as tax implications.
In this article, it covers the business structures highlighted above and what they mean for your pay and other financial connotations. In addition, it discusses how you decide on a certain figure that you will pay yourself.
Here’s what we cover:
Running a self-employed business
As a sole trader or a partner in a partnership, you’re considered to be self-employed and you pay yourself simply by withdrawing cash from the business.
These personal withdrawals are counted as profit and are taxed at the end of the year.
As such, it’s extremely important to set aside a percentage of your earnings throughout the year, preferably in a separate business bank account, so you have enough money to pay your tax bill.
Using accounting software is a good idea, so you can keep an accurate track of your transactions.
This will also make completing a tax return easier.
You’re obliged to pay your tax at the end of the year. And if your net income is above €5,000, you need to set yourself up on Revenue.ie.
When you do this, your Personal Public Service (PPS) number becomes your Tax Reference Number (TRN).
The same tax scale applies as for PAYE and you’ll have to pay income tax, Pay Related Social Insurance (PRSI) and Universal Social Charge (USC) on your net business profits.
Self-employed taxpayers are entitled to an Earned Income Tax Credit of €1,700, which is equivalent to the Employee Tax Credit for employees.
A partnership is similar, with the person responsible for keeping records called the precedent partner. They must submit the annual return.
Each partner must pay income tax, PRSI and USC on their share of business profits. You include your share of the business profits in your own personal tax return.
When you register the partnership, Revenue will issue a TRN for the partnership. Your personal tax matters will be dealt with under your PPS number.
Benefits of sole trader/partnership
Setting up as a sole trader or partnership is easier than a limited liability company, with less bureaucracy and less expenses.
You’re also not required to file annual accounts with the Companies Registration Office.
Running a limited liability company
A company is a legal structure and is a separate legal entity from those who run it.
As a limited liability company owner or director, you can receive a salary, with taxes being paid in the same way as a PAYE employee and the salary is treated as an expense on the company accounts.
Your company must also pay corporation tax on its business profits at a rate of 12.5%.
Revenue will issue a TRN for the company and your personal taxes will be dealt with under your PPS number.
Bureaucracy and compliance are more onerous for limited liability companies than for sole traders or partnerships.
If you own more than 15% of the shares of the company, you’re classified as a proprietary director, and you must also submit an annual income tax return, even if all tax is paid by the company through the PAYE system.
However, as a proprietary director, you may not have to pay PRSI.
For proprietary directors with a shareholding of less than 50% of the company, the PRSI treatment is established on a case-by-case basis.
Proprietary directors are also not entitled to the Employee Tax Credit. However, they may be entitled to Earned Income Credit.
Benefits of a limited liability company
A benefit for a limited liability company is that the corporation tax rate on profits of 12.5% is lower than the rate sole traders pay on profits.
Sole traders can pay up to 40% on profits through income tax.
There is also more pension flexibility with a limited liability company.
A way of saving on tax and getting profits from your business into your own name is through a director’s executive pension.
As a director of a limited liability company with a shareholding of at least 5%, you have generous pension funding options.
You can ring fence profits as a pension contribution and, at the same time, the company will also avoid the 12.5% corporation tax due on these profits, within certain limits.
Revenue allows extra single contributions to be made into an executive pension, with the possibility for spreading the tax relief over a number of trading years, which will potentially reduce the corporation tax in each of those years as well.
Also, as a director, you can receive a salary and then top it up with dividends from the company’s profits.
If your company pays dividends, these will be taxed differently (you can find more information on Revenue.ie).
Generally speaking, a director’s salary taxed under PAYE usually has a lower tax liability than a dividend. Dividend payments are also not included for pension funding calculations.
How much should you pay yourself as a business owner?
Once you’ve decided how you are going to be paid as a business owner, then the focus is on deciding what to pay yourself.
Normally, the higher this figure the better, but you need to strike a balance.
Decide what you need on a personal level to fund your lifestyle and other financial obligations (such as a mortgage, household bills, car loan, etc) and what your business needs to comfortably sustain itself.
In terms of the business, you need to take account of all your outgoing expenses.
In addition, it would be prudent to put money aside for a rainy day fund, should something unexpected happen.
And you’ll also need to ensure there’s money to reinvest in the business, perhaps for new equipment or for funding a marketing campaign.
How the co-founder of MyWallSt decided how much to pay himself
John Tyrell went through this thought process. He left the security of a well-paid technology job at Vodafone, where he’d worked for more than 12 years since graduating from university, to set up an online investment company, MyWallSt, with a colleague.
He says: “Stepping away from a big job with loads of security was daunting, but the thrill of setting up a business and bringing our own values and skills into something we owned and ran ourselves more than made up for that.”
John also ruminated on what to pay himself.
He says: “When we set up MyWallSt (formerly Rubicoin), our focus was on investing as much money as possible into the business to fuel its growth, so we set our salaries based on the minimum amount we needed to get by while we focused on the business.”
Also, as the company needed significant funding, he felt a limited liability company was the best option.
He adds: “Primarily, we were conscious of the need for external funding to build the business and a limited liability company is the most attractive for investors.
“A partnership would have been a possibility, but would have limited our ability to bring in new investors over time.”
Make sure you understand all the ramifications when considering your salary
There are many important issues to consider before deciding on your pay as a business owner.
While setting up a business is an exciting time, it’s also a nervous time.
You’re probably leaving the security of being an employee where you know exactly what you’re going to be paid each month and most likely don’t have to worry about where the money comes from.
It’s different when the responsibility lies with you.
But that’s not a bad thing.
After all, when you run your own business, you could find yourself with a bigger income than you’d have as an employee (and you’d know exactly where the money was coming from).
With such important decisions to make, it may be worth paying for professional advice.
Alternatively, there is ample free advice that you can avail of. A good starting point is your Local Enterprise Office.
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