Becoming an entrepreneur offers many benefits compared to traditional options, including flexibility, entrepreneurship, and freedom.
Of course, owning a small business is riskier, but it can also provide substantial profits compared to a standard 9-to-5 employment, especially if you know how to optimise your earnings.
The options reviewed below vary in tax procedure and what your year-end payment routine will look like and should be reviewed with an expert. Making the right choice is crucial for your business and your personal needs.
What are my options as a Small Business Owner
Small business owners traditionally have two popular routes:
- Being a sole trader, wherein your business income is considered personal income: Your income is straightforward and comes in what is regarded as a“business drawing” You pay tax on these drawings via a self-assessment tax return.
- Operating through a partnership or limited company: You can pay yourself via salary and dividends dispersed to all shareholders.
The best payment method depends wholly on what type of business you run–and the classification of such.
If you are a sole trader
Operating as a sole trader is very straightforward. Establishing as a sole trader is a must if you meet any of the below criteria:
- Your self-employed income for the previous tax year exceeded £1,000
- You need to prove your self-employment status to participate in benefit programs
- You voluntarily would like to make Class 2 National Insurance payments to assist with benefit qualifications
As a sole trader, all of your revenue generated is considered your personal income—there is no separation between you as a person and your business. This makes tax payments relatively straightforward, as you’ll only need to inform HMRC that you pay tax through self-assessment and file a self-assessment tax return each year.
If you trade through a limited company or partnership
Trading through a corporation requires more administrative work but might pay off more. You’ll need to run payroll to calculate statutory deductions, such as tax, National Insurance, student loans, and benefit-in-kind.
Salary
In order to do this, the company must be registered with HMRC.
You must use the HMRC basic tool or payroll software like Moonworkers to deduce tax and national insurance contributions on your salary and submit your complete payment submission (FPS).
Many directors draw a salary below the yearly personal allowance to reduce tax.
From 2024 to 2025, the personal allowance threshold is £12,570. This means that, provided you have no other relevant income within the tax year, you can draw a salary up to this amount without the need to pay income tax.
Above the allowance, the amount of tax you will pay depends on the specific salary range within which your earnings fall.
If you pay yourself solely in salary, you would pay income tax as follows:
- First £12,570 at 0%
- Between £12,571 and £50,270 at 20%
- Between £50,271 and £125,140 at 40%
- Over £125,140 at 45%.
Notice that HMRC has introduced a PA reducer for earnings over £100,000. For every £2 earned over £100,000 each year, you would lose £1 worth of the £12,570 tax-free personal allowance.
Different rates and thresholds will apply to you if you live in Scotland.
Finally, it is important to remember that HMRC has simplified the above numbers to make them accessible. In fact, tax deductions are calculated using the exact percentage method, introducing specific rounding rules and formulas when salary is paid more frequently than annually.
Dividends
If the company makes a profit, then shareholders can receive dividends. All shareholders must proportionally receive the same amount of dividends.
HMRC introduced a nil rate of taxation applied to the first £1,000 per annum.
After that, dividends will be taxed by bands.
- Basic Rate: 8.75%
- Higher Rate: 33.75%
- Additional Rate: 39.35%
However, the tax includes all your earnings subject to class 1A NI, not just dividends. For example, if you had received income up to the higher rate tax threshold and then paid yourself a £5,000 dividend, the first £1000 would be taxed at 0%, and the remaining £4,000 would be subject to the higher rate of 33.75%.
You can find additional details on the UK government website.
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