Tip Tuesday: When Should You Add Yourself to the Payroll System?

Small Business

As a business owner, you have a few options when it comes to paying yourself. One of these includes adding yourself as an employee to the payroll system. But you need to always balance your own pay with the financial needs of your business. So what’s the best way to do that?

Think about your pay

If you’re a business owner thinking about your remuneration, ask yourself these questions:

  • How do you pay yourself? The options are salary through payroll, dividends, loans and taking money out as needed.
  • How much should you take? Enough to get by? Enough to be comfortable? More than the highest paid employees?
  • When should you take money out of the business?
  • Is it ever okay not to pay yourself?

In this guide we’ll help you answer these questions, so you’ll know how and when you should pay yourself.

Businesses must be built

Before looking at paying yourself, you need to think about the flow of money into your business. Businesses need investment to grow. In fact they often need it just to keep pace with developments in their market.

Some investment comes in the shape of employee skills, which is why it’s important to hire the right employees.

But some investment needs to be in the form of cash, which might come from:

  • Financial investment. This may come from you, fellow owners or directors, or anyone else. Investors need to be paid back under agreed terms. These usually include providing a return on the original sum.
  • Grants. These tend to be for specific uses so are only worth applying for if you need what they fund.
  • Profit. This is the money left over after salaries, taxes and other costs have been met. It can be freely reinvested in the business.

In the early stages, your business will probably consume all the cash it receives from these sources. So with all of this need for money, where does your pay fit into the picture?

Consider the three stakeholders

There are three key stakeholders who will be affected by how you choose to pay yourself:

  1. You!
    • It is important that you can meet your living expenses.
    • You need to feel you are running the business – and not that it’s running you.
    • You need to keep on the right side of the law.
  2. Your employees
    • How will employees respond to the balance you have chosen between your own pay, theirs, and the needs of the business?
  3. The business
    • What are its growth needs likely to be in the coming period?
    • How will you support these – financially and in other ways?
    • Are your plans viable, taking into account the needs of the other stakeholders?

Understand your options

It’s vital to understand the options for paying yourself as business owner – and make the right choice. Here are the main options:

  • Salary through payroll
    You will be enrolled into the payroll system and your salary will be paid at regular intervals. For taxation purposes you will be treated like an employee. It sends a positive signal to employees when the owner is on payroll – just like them. Payroll is also a good way for you to ensure you have a regular income to live on comfortably. It can keep you free from financial anxiety.
  • Taking out money
    Taking money out of the company as and when you need it might sound attractive. But there are disadvantages:

    • Taking irregular sums from the business may attract the attention of the tax office.
    • Budgeting for investment is difficult if you don’t have a clear idea of the business’s financial status every month.
    • Unstructured withdrawal of funds could deplete the company’s finances.
  • Loans
    Taking a loan from the company. This can sound appealing. But loans are made with an agreed interest rate and repayment dates. There are penalties if they are not repaid. There are also potentially serious consequences if the company goes into liquidation.
  • Dividends
    A way for business owners and shareholders to take a sum out of the yearly profits. Dividends are often used as a legitimate way to reduce tax liability. They are best seen as a complement to a regular salary through payroll, not a substitute for it.
  • Not paying yourself
    This is always an option if you are the company owner. It is only worth considering if the business is struggling, perhaps in the early stages. Obviously you’ll have to be in a financial position to support yourself through other income.

Which one is right for you? It depends on your business circumstances, but salary through your payroll system is a common choice. Talk to your accountant or financial advisor to get more information about each option.

Be aware of the non-financial consequences of your choices, too. For example, the lure of minimising taxes is strong. That may pull you towards dividends or a loan rather than regular salary through payroll. But employees may resent you taking steps to minimise your tax liabilities, when they can’t.

The need for payroll

Depending on the legal structure of your business, you may be required to take a salary through payroll. There are regulations to this effect all around the world. They vary slightly, but it’s helpful to look at the US as an example:

  • In the US, any company registered as a corporation in which individuals own stock must include all staff on the payroll. This ensures you pay social security, Medicare, and federal and state income taxes.
  • Your company may be an S Corporation. That means shareholders receive income from the company and treat this as personal income. If so, you can take income as a dividend or as a draw, in addition to payroll.
  • In both cases, the IRS requires that you earn reasonable compensation through payroll in comparison to others in similar jobs. The IRS may want to take a closer look if it feels you are using draws instead of payroll in order to avoid taxes.

This example shows that it is vital you understand the regulations – wherever you live. If you don’t take at least some of your income through payroll, you may be breaking the law. A good accountant will help you work through the red tape and find out what your obligations are.

Simplifying the process

Good payroll software will handle paying your employees properly. It will also ensure that you pay yourself correctly, if that’s your chosen way to compensate yourself. Look for payroll software that:

  • is flexible and scalable, so it will grow with your business
  • can handle local accounting regulations
  • is cloud-based, so you can access it online using a tablet, smartphone or laptop
  • gives you the ability to log in from anywhere, at any time
  • integrates with your accounting software so you don’t have to enter any numbers twice
  • lets you share data securely with your accountant.

It’s a good idea to hire an accountant, tax professional or financial advisor to review how you set up your payroll system. But keep in mind that at the end of the day, you are legally responsible for getting it right.

Payroll deductions work in your favour

Some of the expenses you incur while running your business can be claimed back from the business. Some common deductions include:

  • entertainment
  • travel
  • vehicle expenses
  • start-up costs
  • office space
  • legal and professional fees (such as your accountant and lawyer)
  • interest charges on a loan or credit card.

This can work in your favour when calculating what your business owes you. Make sure your payroll accounting software is capable of handling these expenses.

Find the right balance

As you can see, there is no single set of rules for how business owners should pay themselves. You may work longer hours than your employees yet take a smaller salary through payroll.

Even when your salary is topped up by a dividend that you feel is fair, you may still not be the highest paid person in the company.

Perhaps that doesn’t matter. Compensating yourself comes down to meeting two key requirements. Those are:

  • to pay yourself enough to be comfortable
  • to ensure the business remains viable and able to invest in its staff and its future.

Taking at least part of your income as salary through payroll will help you meet these conditions.

Never forget the bigger picture

As the owner of the business, you stand to do very well financially if the business grows and generates a lot of profit. Your goal may even be to sell the company and retire after a few years.

So whatever method of payment you choose, don’t feel the urge to take out too much money from your growing business. It might be worth you taking a small salary through payroll in the short term so you can reach your goal – and reach it quickly.

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