I am a Startup Founder in the UK. When Do I Start Paying Myself a Salary?

Suppose you are a small business owner with no employees who has just invoiced your first client or sold a good to your first customer. After making some profit, you will probably wonder how to pay yourself a portion of the proceeds. For early-stage startups, this process may be confusing. This article will explain how paying your own salary as a startup founder works, either as a sole trader or through a private limited company. In addition, it will also briefly explain your tax liabilities in the early stages.

Paying Yourself as a Sole Trader 

If you are a sole trader, there is no legal distinction between your earnings and your business’ earnings. In other words, when you receive money from a customer or client, they are essentially paying you directly. 

This means that there are no formalities when it comes to paying yourself a startup founder salary, or founder compensation. Your business profits are legally your profits. Therefore, you are free to spend your business’ earnings as you see fit, keeping in mind any liabilities or debts you may have to cover.

Income Tax

Depending on how much you earn, you may need to pay income tax on your salary as a startup CEO. As of the current tax year (6 April 2021 – 5 April 2022), your income tax rates are as follows: 

*Your Personal Allowance may be different if you either:

• claim the Blind Person’s Allowance; 
• claim Marriage Allowance; or
• earn over £100,000. 

**The Government’s recent Budget Announcement in October 2021 has not made any changes to the next tax year. 

National Insurance Contributions 

You will also have to pay National Insurance Contributions (NIC) in most cases. This is because most sole traders fall into Class 2 (if your profits are more than £6,515/year) or Class 4 (more than £9,569/year). 

The rate breakdown is:

How Will My Tax Liability Be Calculated and What Records Should I Keep?

HMRC will calculate your tax liability based on your Self Assessment. The deadline for filing your Self Assessment is:

• 31 Jan 2022 for online tax returns; and
• 31 October 2022 for paper tax returns. 

You will need to make a payment by 31 January 2022 or face a penalty. 

To help prepare your Self Assessment, you should keep the following information on hand:

• all sales and incomes and either the dates you:
  • sent the invoice; or
  • received the money.
• all business expenses; 
• all your personal income; and
• any grants you received through the Self-Employment Income Support Scheme.

Paying Yourself as the Sole Director-Shareholder of a Company 

Companies are their own legal persons, which means they are distinct from you, even though you may be the only owner. 

Therefore, you cannot effectively transfer the money paid to the business directly to yourself as the startup CEO’s salary. Instead, your company must account for all money it receives (revenue) and all the money it owes (expenses). 

Companies benefit from their own tax liabilities and benefits. These liabilities and benefits are separate from your personal tax liabilities. 

If you are a director, you can pay yourself in three ways:

• a salary;
• dividends on your company’s profit; and
• a loan from your company to its director (you). 

Salary 

You can pay yourself a salary as a director. The benefit is that you can obtain a regular payment at fixed incomes. There are also tax benefits to doing so, mainly because a salary is treated as an expense and therefore, the company does not pay taxes on it.

The disadvantage is that you will have to declare yourself an employee and ensure that you are keeping up with the administrative requirements in paying yourself a salary. Most notably, you will need to register with Pay As You Earn (PAYE) and make sure you (as an employee) and your company are making the correct National Insurance Contributions. 

Dividends 

A dividend is money paid back to the shareholders. Directors can decide when to issue dividends. Since you are the only director, you are in an excellent position to pay yourself when you see fit. 

Additionally, you can declare a dividend only if your company has made a profit. 

Since a dividend is part of your company’s ‘profits’, your company will pay 19% in tax. 

You may also be liable for an additional amount of taxes in your personal capacity, depending on how much more you pay yourself in dividends over £2,000. 

Practical Implications 

Most directors draw no more than £12,570 in salary. This is because neither the company, nor you personally will pay any tax on this amount since this falls within your personal allowance as a low salary. So if you want to avoid paying any money to NIC, the maximum amount you can pay yourself is £737 a month (£8,884 per year). A higher salary would mean more tax obligations.

Additionally, you can draw up to £2,000 in dividends with no personal tax liability (though your company has to set aside 19% of this to cover its taxes). After this amount, you will be taxed according to your income band:

Following this, most directors will draw as little as they need to in dividends and keep the rest in retained earnings. 

Key Takeaways

The method of paying yourself a salary as a startup founder depends on your business structure. For example, if you are a sole trader, you can pay yourself however much you like, subject to covering any debts or obligations to your suppliers or service providers. You will just need to account to HMRC once per year by completing a Self Assessment. 

If you are the sole director-shareholder of your company, you have more options, which you can use to limit tax liability. The most common way directors pay themselves is no more than £12,750 in salary (or less, depending on how much you wish to contribute to National Insurance). If you pay yourself a salary, you need to ensure you meet your obligations to account for PAYE and NIC. You can pay yourself any amount above £12,750 in dividends, but only if your company has declared a profit.

If you need help with navigating your directors’ duties for early-stage startups, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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