There’s no doubt that one of the best parts of running your own business is when all those hours of work are suddenly transformed into cold hard moolah.
For sole traders, this process is fairly straightforward: you ‘are’ your business, and you pay yourself by drawing money directly from the company. (Just remember to keep those records accurate).
Directors of limited companies have a couple of different options available to them when it comes to their ‘remuneration strategy’ (accountant speak for ‘how you pay yourself’). The two most common are paying themselves a salary, or taking dividends. This post will take a look at each of these, and explore what the best way to get paid might be. But first…
This is something that all owners of limited companies should be taking advantage of. Two grand of tax free money, available to withdraw every financial year. As we’ll explain later, as long as the business has made enough profits to allow for it, this one’s a bit of a no-brainer. It’s after that things start to become a bit more complicated.
Before we get started on the best way to pay yourself, we do always stress that the right way to approach this will be different for everyone: you may have different goals for your business or you may earn money outside the company. We’d always recommend talking your situation through with one of our tax experts before making any decisions, just to make sure your payment strategy really is the best one for you. However, an understanding of the two main payment options available to you as a company director is useful.
The first key point to understand is the difference between a salary and a dividend.
Taking a salary means that the company pays you a set amount each month, just as would be the case if you were working for someone else. Salaries are paid through the PAYE (pay as you earn) scheme, and are subject to income tax as soon as they hit £12,500 (the threshold for the 19/20 tax year). Importantly, that means any salary below this is tax-free.
Salaries are also subject to National Insurance Contributions: you pay 12% as soon as your earnings reach £166 per week. It’s a good idea to meet this threshold, as it means you’ll qualify for a state pension when you retire. But of course, you don’t want to pay more than you need to. At the time of writing, the minimum salary to meet this target is £8,632 per year.
For these reasons, many company directors opt to pay themselves a small salary that sits between the two thresholds mentioned above: avoiding income tax but minimising NI contributions.
(Note – if you employ other people, you may be able to claim employment allowance, which lets you claim up to £3,000 back from the NIC contributions you make for your employees. The maths gets complicated here, but if you do qualify, it may work out better for you to take a salary closer to the £12,500 threshold.)
One final but important point to mention is that any salary paid by your company is deductible against the company's corporation tax.
So - a small salary is a good idea for many companies. Once your salary is sorted, it’s time to look at your dividends. Remember, these are the profits you take from your company. To understand how this might work, let’s use a quick example:
Sticking with our example, your £9K salary means you have another £3.5K of dividends to take before you reach the income tax threshold. Combined with the dividend tax allowance, the business has now paid out £14.5K completely tax-free. Should you need it, you still have £14K left in the business to take out as dividends.
These dividends will be taxed, but the rate is still lower than income tax, and you don’t need to pay National Insurance, which is why most company directors go down this route. Basic rate taxpayers will pay 7.5% on their dividends. Higher rate earners (those earning £50K or more) will pay 32.5%.
So yeah, dividends are a pretty good way to go. Just a couple of things to watch out for:
So there we have it. As with so much in life, a balance can be a good thing when it comes to taking a salary from your company. At Mazuma, our specialist tax accountants can help you make sure you are paying yourself in the most tax efficient way, and getting the most return from all those hours you put in. Get in touch to discuss your situation whenever is convenient for you.