The Scenario Nobody Talks About
Most advice on paying yourself as an agency founder assumes your company has retained profits. The standard model is clear: take a salary up to the NI threshold (£12,570 for 2025/26) and draw the rest as dividends to save on National Insurance.
That works perfectly when your profit and loss account shows a positive retained earnings balance. But what happens when it doesn't?
If your agency has accumulated losses from earlier years, maybe from the startup phase, a bad year during COVID, or a failed project that burned through cash, you may have a negative retained earnings figure on your balance sheet. In that situation, you cannot legally pay dividends. Company law (the Companies Act 2006) says dividends can only be paid from distributable profits. If you don't have them, any dividend payment is unlawful.
So how do you pay yourself agency founder when the retained earnings are in the red? You use a bonus. And you structure it carefully to minimise the combined tax hit.
Why You Can't Just Ignore the Retained Losses
I have seen agency founders pay dividends out of accumulated losses because their cash flow was healthy. They looked at the bank balance, saw money, and assumed that meant profits were available.
It does not work that way. Retained earnings are a historical record of all profits and losses since the company started, minus everything distributed to shareholders. If that number is negative, there are no distributable reserves. Paying a dividend in this situation is a breach of director's duties and can trigger:
- A legal requirement to repay the dividend to the company
- Personal liability for the directors who authorised it
- HMRC penalties if the dividend was used to avoid tax
- Issues with your accountant signing off year-end accounts
This is not a corner you want to cut. If your balance sheet shows negative retained earnings, you need a different route to get money out of the business.
The Bonus Alternative: How It Works
A bonus is simply a discretionary payment from the company to you as an employee or director. Unlike dividends, bonuses are not restricted by retained earnings. They are a cost to the company, deducted from trading profits before corporation tax is calculated.
That is the key difference. A dividend comes from post-tax profits. A bonus reduces the profit in the first place. This creates a tax trade-off that you need to understand before deciding how much to take.
The Corporation Tax Saving
If your agency is profitable this year but still has accumulated losses from prior years on the balance sheet, any bonus you pay reduces this year's taxable profit. At the 25% main rate of corporation tax (for profits over £250,000) or 19% (for profits under £50,000), that saving is significant.
Example: Your digital agency turns a profit of £120,000 this year. You have £80,000 of retained losses from previous years. You want to draw £60,000 personally.
- If you pay a £60,000 bonus, the company's taxable profit drops from £120,000 to £60,000. Corporation tax saved: roughly £13,800 (marginal relief calculation, but the principle holds).
- If you could pay a dividend instead, the company would pay corporation tax on the full £120,000, and you would pay dividend tax on the £60,000 personally.
The bonus saves corporation tax at the company level. The cost is that you pay income tax and employee NI on the bonus personally, and the company pays employer NI of 13.8% on top.
The Personal Tax Cost
Let us run the numbers on that same £60,000 bonus for a higher-rate taxpayer in 2025/26.
- Gross bonus: £60,000
- Employer NI at 13.8%: £8,280 (this is an additional cost to the company, not deducted from your bonus)
- Your income tax at 40%: £24,000
- Your employee NI at 2% (above the upper earnings limit): £1,200
- Net cash in your pocket: £34,800
Compare that to a dividend of £60,000 if retained earnings were available:
- Dividend tax at 33.75% (higher rate): £20,250
- Net cash in your pocket: £39,750
The dividend leaves you with £4,950 more personally. But that comparison only works if dividends are legally available. When they are not, the bonus is your only option, and the corporation tax saving partially offsets the personal tax cost.
Structuring the Bonus to Minimise the Overall Bill
You have some control over timing and amount. Here is how to think about it.
Keep the Bonus Within the Basic Rate Band If Possible
If your total income (salary plus bonus) stays below £50,270, you pay 20% income tax instead of 40%. That changes the maths significantly.
For a basic-rate taxpayer taking a £40,000 bonus on top of a £12,570 salary:
- Income tax at 20%: £8,000
- Employee NI at 8% on the band between £12,570 and £50,270: £2,194
- Net cash: £29,806
- Effective tax rate: 25.5%
That is far more palatable than the 42% effective rate a higher-rate taxpayer faces. If you can keep your drawings below the higher-rate threshold while the retained losses are cleared, do it.
Time the Bonus Around Your Year-End
Bonuses are deductible in the period they are accrued, not when they are paid. If your company has a 31 March year-end and you accrue a bonus in the accounts for that year, it reduces that year's corporation tax liability even if you do not pay the cash until June.
This is useful if you know the retained losses will be cleared by the next year and you want to switch back to dividends. You can accrue a bonus in year one, pay it early in year two, and then start taking dividends once the retained earnings turn positive.
Watch the Directors' Loan Account
If you take money from the company without declaring it as salary or a dividend, it goes into a directors' loan account (DLA). If the DLA is overdrawn (you owe the company money) and is not repaid within nine months of the year-end, the company pays a Section 455 tax charge at 33.75%. That is a penalty you want to avoid.
If you are in the retained-losses situation and need cash quickly, process it as a bonus through payroll rather than taking a director's loan. The payroll route is cleaner and avoids the S455 headache.
What About Clearing the Retained Losses First?
You might ask: can I just wait until the retained losses are cleared by future profits, then pay dividends?
Yes, but that takes time. If your agency makes £50,000 profit this year and has £40,000 of retained losses, you will clear the losses by year-end and have £10,000 of distributable reserves. You could then pay a dividend of up to £10,000. But you have to wait until the accounts are finalised and the reserves are confirmed.
In practice, most agency founders cannot wait that long. They need cash flow for living expenses. A bonus gives you immediate access to the money while the retained losses are gradually cleared.
Mixing Bonus and Dividend in the Same Year
Once your retained earnings turn positive, you can use a hybrid approach. Take a smaller bonus to cover the gap until the year-end, then pay a dividend after the accounts are signed off.
Example: Your agency has £20,000 of retained losses at the start of the year. You expect to make £100,000 profit. Mid-year, you need £30,000 personally. You cannot pay a dividend yet because the losses are not cleared. So you take a £30,000 bonus.
By year-end, the retained losses are cleared and you have £80,000 of distributable reserves. You can then pay a dividend of up to £80,000. In future years, you revert to the standard salary-plus-dividend model.
This is a transitional strategy. Once the retained losses are gone, you should move back to dividends for ongoing drawings. The bonus is the bridge, not the destination.
The PAYE and Reporting Requirements
Bonuses are processed through your payroll software (Xero, QuickBooks, FreeAgent, whichever you use). You report them on a Full Payment Submission (FPS) to HMRC in real time. The employer NI is calculated automatically and paid through your monthly or quarterly PAYE bill.
Unlike dividends, bonuses do not require a board meeting or dividend voucher. You do need to document the bonus decision in the company records, a simple board minute confirming the amount and the basis for it is enough. Your accountant will want this for the year-end file.
If you are an ICAEW qualified accountant like our team at Agency Founder Finance, we will check that the bonus is commercially justifiable. HMRC can challenge excessive bonuses if they look like a disguised dividend, but if you are the sole director and the bonus reflects your work for the company, there is usually no issue.
When a Bonus Is Actually Better Than a Dividend
Even if you have retained earnings available, there are scenarios where a bonus beats a dividend.
If your agency is in the 19% small profits rate band for corporation tax, the tax saving from deducting the bonus is relatively small. But if you are in the 25% marginal relief band or the full 25% rate, the corporation tax saving becomes more attractive.
There is also the question of pension contributions. Bonuses can be sacrificed into a pension via salary sacrifice, avoiding both income tax and NI. You cannot do that with dividends. If you are building your pension, a bonus routed into a SIPP is highly tax-efficient.
And if you are planning to sell the agency and claim Business Asset Disposal Relief (BADR) at 14% capital gains tax, keeping retained profits in the company rather than distributing them as dividends can increase the value of your shares. That is a longer-term play, but worth considering.
Practical Steps: What to Do This Week
If your agency has retained losses and you need to draw money, here is your action plan.
- Check your last set of filed accounts. Look at the retained earnings figure on the balance sheet. If it is negative, dividends are off the table.
- Estimate this year's profit. Your management accounts will tell you whether you are on track to clear the losses. If yes, plan the timing of your bonus to align with the year-end.
- Run the payroll calculation. Use your software to model the bonus amount, including employer NI. Make sure the company can afford the total cost.
- Document the decision. A simple board minute is enough. Your accountant will thank you.
- Speak to your accountant. If your retained losses are significant and you are unsure about the timing, ask them before you process the payment. They can run the full tax comparison for your specific numbers.
Our services page covers how we handle these situations for agency founders. If your contractor mix or structure has changed recently, it is worth reviewing your approach to drawings as well, read our guide on contractors and IR35 if that applies to you.
The retained-losses situation is more common than most agency founders realise. It is not a problem. It is a planning opportunity. With the right structure, you can get the cash you need without paying more tax than necessary.