Obviously, if you own and operate a limited company, you will want to be paid! In this article, we look at the various options which are open to business owners when it comes to extracting an income from the business in the most tax-efficient manner. Although the days when company directors could extract £5000 in tax-free dividends are long gone (the current allowance for tax-free dividends is just £2000), with some foresight it’s still possible to pay yourself up to £13,850 before tax is liable. Discover how to optimise your income at the same time as ensuring your company operates in a legal manner below.
Two different methods of receiving payment
As a company director, there are two ways in which you can receive profit from your business: dividends and a salary. If you pay yourself a salary, it’s classed as a tax-deductible expense for your business and is therefore not subject to corporation tax. It is, however, subject to income tax and NI contributions once it’s paid across to you. The other way of receiving income from your company is through a dividend: a lump sum which is distributed to shareholders from the profits the company makes. If you are the sole director and the company hasn’t sold shares to others, it’s likely that you will be the sole beneficiary of the dividend payment. Dividends are frequently paid quarterly but may be paid bi-annually or even annually. Dividends do not incur corporation tax (so your business won’t pay tax on them), but they do incur personal dividend tax should their total value exceed £2000 in any given tax year.
What is the most tax-efficient method of payment?
Obviously tax-efficiency is influenced by a number of different factors: for example, an individual who earns a salary which puts them in a higher tax bracket or who receives dividends from several different companies may need to structure their financial affairs slightly differently in order to keep their tax burden as low as possible. Presuming that you receive no other income from other sources, the most tax-efficient method of payment is through a combination of salary and dividend.
Make the most of your tax-free allowance
The government allows individuals to earn up to £12,500 (for 2019/20 income) without paying tax. This equates to £1041 pcm tax-free. You will, however, need to pay Class 1 National Insurance Contributions on earned income above £166/week. If you opt for the £1041 monthly salary figure, you will need to pay Class 1 NICs at 12% on about £322 of your income each month. If you decide to earn the maximum tax-free allowance, note that your business will need to register as an employer and have a real-time payroll system in place. Your business will also need to pay NI employer’s contributions on your salary unless it’s eligible for the Employment Allowance. The Employment Allowance applies to businesses with an NI bill of £100,000 or less, giving them a £3000 reduction in NI contributions. If you are the sole employee and drawing only your tax free allowance as salary, your business won’t need to pay NI Employer’s contributions.
Top up your salary with a dividend
You can add an additional £2000 of tax-free money to your payment through a dividend (as of 2019/20). Note that if the dividend is in excess of £2000 (or you have other dividends which total more than £2000), then you will need to pay dividend tax. Rates vary depending on the amount of dividend, but if you are a basic rate taxpayer, you will pay dividend tax of 7.5%. Note that this is still significantly less than the basic rate of income tax, currently set at 20%. Due to this tax difference, some directors opt to receive a lower salary and higher dividend in order to optimise their tax position.
Whilst the most tax-efficient way of extracting payment from your business is fairly straight-forward for smaller businesses, it can become more complex as the business grows. Business owners who also have additional income from other sources or complex financial arrangements may well benefit from high-quality, professional accountancy advice in order to achieve the most tax-efficient outcome. Please feel free to contact us for further advice.