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Sole Trader Drawings Or Wages? The Answer Is Fairly Simple

Sole trader drawings or wages? The answer is fairly simple

Are you a newly registered sole trader and trying to determine how you’ll extract money from your business? Being self-employed as a sole trader is very different to being employed by a company, or even owning a limited company, and you should equip yourself with all the knowledge that you need in order to make the most out of your position as a sole trader. There is a fair amount of effective financial planning needed if you want to operate successfully as a self-employed person.

Many sole traders get a bit confused when it comes to the topics of drawings and wages, so in this article, we’ll explain the differences between the two and which method you should be using as a sole trader to ensure you’re fairly compensated each month for the work you do.

The Differences Between Wages And Drawings

Most people are familiar with how wages and salaries work. Wages and salaries are weekly and monthly payments made from a company to the employee. Wages can only be paid by registered companies and employers. If you own a company of your own, you can register as an employer and pay yourself a wage. Wages are seen as an allowable business expense and are tax-deductible. All wages need to be calculated and recorded through PAYE.

Drawings are made by sole traders from their business accounts and are seen as the sole trader’s personal income. Because their personal finances and business finances are so closely linked, sole traders can make drawings wherever they see fit. Drawings are not seen as an expense when calculating business profit and are not tax-deductible. Because drawings are seen as the owner’s personal income, all drawings are taxed accordingly. The greater profit you make, the higher your tax will be.

As A Sole Trader, Can I Pay Myself A Wage?

Contrary to what many people think, if you are a sole trader, you do not pay yourself a wage. As you are not a limited company, you can’t pay yourself a wage, and all funds extracted from your business will have to be done so through drawings.

Paying yourself a wage is a completely different structure and can only be done so through owning a limited company.

 

sole trader paying out drawings

 

How Should I Structure My Drawings?

As a sole trader, your finances and your business finances are basically linked, but you want to keep them separate so that your personal expenses and business expenses don’t get confused. An advisable solution would be to create a separate drawings or business account. This way you’ll be able to keep your finances separate and be able to gain a clear understanding on your business finances as well as your profits.

If you are someone who needs a bit more structure and stability when it comes to your finances, you may want to pay yourself a set amount each week or month – essentially meaning your drawings act as a regular salary. Find an amount that will remain under your profit margin and pay it out to yourself regularly so you have a steady and consistent flow and you can keep track of your expenditure and be able to budget and balance your finances, as well as save towards bigger expenses such as a new car or a holiday.

Setting Up A Drawings Account

If you want to manage your cash flow better without relying on the same current account that you rely on for personal use, then a drawings account can be a great alternative for many sole traders – these business accounts support with recording drawings, making it clear to HMRC the money you use as personal drawings each month (essentially acting as your salary), and the money you might use for your business expenses, such as paying other businesses for goods and services you need to service your customers as a business owner operating as a sole trader.

You might consider drawing accounting if your sole trader business finances are becoming more complex to manage. Here, you pass the responsibility of recording your personal drawings and business expenses to a registered accountant instead, giving you the time to focus on your business. This isn’t, of course, for everyone, but may work for some if you prefer the business side of your sole trader setup, rather than the financial side.

What About My Taxes As A Sole Trader?

You are personally liable for all of your tax bills, so it is very important that you keep detailed records of all of your drawings as they are seen as profits. Before the 31st of January each year, you’ll need to submit a self-assessment, and you’ll be taxed on your profits. There are certain thresholds below which you won’t be taxed, but you’ll still need to submit a self-assessment no matter what. General UK government guidance is that if you earn over £1,000, then it should be declared in a self-assessment, even if you don’t reach the threshold for tax.

You should also note that you must make an effort to retain sufficient funds in order to pay tax on your profits, or you could be in for some trouble. Most experts recommend saving around 25% of your drawings for tax purposes in the future. This should more than cover any tax bill you are given at the end of the tax year, meaning you’ll have a little left over in savings, too.

National Insurance Contributions are another thing that you’ll have to consider. These will only be applicable to you once you start earning over a certain threshold. The thresholds for NICs include:

  • NIC Class 2 – Will no longer be required from 06 April 2024, as per the Chancellor’s Autumn Statement which says “From 6 April 2024, no one will be required to pay Class 2 self-employed NICs” (previously this would have to be paid if earning £6,725 or more a year)
  • NIC Class 4 – £12,570 or more a year

 

paying tax as a sole trader

 

What Are Allowable Business Expenses For Sole Traders?

So, if business drawings are not seen as allowable expenditure for sole traders, what expenses are seen as allowable

  • Travel – This includes things like vehicle insurance, fuel, and transport expenses.
  • Legal expenses – Lawyers expenses, business insurance, and accounting
  • Marketing – The cost of advertising and PR
  • Office expenses – Things like stationery, postage, and film bills
  • Clothing – This will only pertain to uniform
  • Business premises – Your rent, upkeep, utility, internet, bills, and security
  • Training courses – Any training undertaken in order to improve your skillset

 

Keep detailed records of all your business expenses so that you can claim back for anything that is an allowable expense in certain situations.

Other Things You Should Know As A Sole Trader

  • You need to register with the HMRC – Whether you’re earning above the tax threshold or under it, you will still need to register with the HMRC when you begin your journey as a self-employed individual. If you don’t, you may be in for some trouble. You’re officially seen as self employed when you earn £1,000 or more from a particular task. You can register with HMRC before this threshold too, if you desire, but it isn’t required before £1,000 is breached.
  • Registering is super easy – If you are put off from registering because you think it’s going to be a time-consuming process, don’t worry, as the whole thing can be done within a couple of hours and the UK government website has plenty of resources to help those who are struggling.
  • There is a fair amount of risk involved when becoming a sole trader – This is because your business finances and personal finances are mixed, so you will be fully liable for expenses whether your business succeeds or fails. This should be well thought out before taking the plunge.
  • You may have to register for VAT – If your profit starts turning over more than £85,000 in a 12 month period, then you will have to register for VAT.

 

If you’re at all concerned about how you should handle your business finances as a sole trader, you should definitely speak to a trusted financial advisor to get sound financial advice based on your specific situation. Over time you’ll gain a better understanding of the ins and outs of being a sole trader and how to handle your finances.

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