Freelancers' Questions: How to pay myself?
Freelancer’s Question: What is the best way for freelance professionals to pay themselves? I've been a freelance designer and illustrator for about three years and have always maintained my finances through my personal account. I am aware this is bad practice, so I have recently opened a business bank account and am now updating my invoice template with my new banking details.
However, how much should I take from my business account as a weekly or monthly wage? While I know this obviously depends on my earnings, is there a standard procedure or amount when it comes to freelancers paying themselves? Also, is the figure eligible to be included as a business expense and therefore be included on my tax return?
Expert’s Answer: First of all, the amount that can be taken out of the business as a "wage" will be solely dependent upon the value of work invoiced. As a freelance designer or illustrator, unless you have a long-term contract with a client then it is likely that this amount will change each month.
Furthermore, the amount, and way, that you pay yourself will depend upon how you're set-up as a business. In our experience, you will either have your own limited company, or more likely you will be working as a self-employed sole trader.
In a limited company, you will usually be a director AND employee of the business. You will therefore take your income as a combination of salary and dividends. This is the most tax efficient way and this is best calculated by sitting down with your accountant.
In this example, you say that you have previously managed your finances through your personal account which would suggest that you are operating as a sole trader. This makes things much easier. Your tax obligations are simply to make your Class 2 NIC contributions each month, which you can do by Direct Debit, and then submit a Self-Assessment Tax Return each year. In terms of how much to pay yourself, we would recommend that you set aside an amount for tax. It may even be worth setting up a high-interest bank account to keep this money in.
You will also have expenses that can be offset against your income for tax purposes, so as a rough guide we would recommend holding 20% of your income back to meet your tax liability. The balance can be used to pay expenses and of course to pay yourself. However, as always it would be best to speak to your accountant and agree a strategy that is tailored to your own personal circumstances.
The expert was Alasdair McGill, managing director of Freelance World, a specialist in service-led accounting & tax services to freelancers in the creative industries.
13th December 2010