Can I employ myself and treat this as an expense?

If you have just become self-employed, you’ve got a million things on your mind and book-keeping and accounting is not usually top of the list.  But there are some important things you need to do in terms of getting registered for various taxes.  What I say below, and the title of this entry, was inspired by a conversation I had last night with someone who was looking for some help with book-keeping.

Let’s assume you become self-employed i.e. you are a sole trader. In any of my books, the early chapters explain the format a business can have (sole trader, partnership or company) and also a fundamental accounting concept – the entity concept. This concept means that the person is separate from the business. So here’s an outline of what happened to this guy I met last night. He lost his job and set up his own business as a sole-trader.  He got some bad advice telling him to register as an employer with the tax authorities and pay himself a wage i.e. he was both the employer and the employee. Under the entity concept this could not happen. Why? When a sole trader makes a profit, a portion of this profit (usually called drawings) can be withdrawn for personal use. Or in accounting  jargon, the business entity gives a portion of the profits to the person behind the business.  Wages are an expense in the accounting world, being deducted from revenues to calculate profits.  And, wages are paid to employees you must by definition be a different person or entity from the employer. If this business was a company however, the story would be different. A limited company is a separate legal and accounting entity, so the guy I was advising could set up a company, be a director of that company and pay himself a wage. So, in summary if you are a self employed sole trader, you cannot pay yourself a wage as if your were an employee; instead you withdraw some portion of the profits to live on.