How can I extract funds through a limited company in the most tax efficient way ?
In this article we address one of the most common questions we receive from business owners – how do I pay myself and make sure I minimise the amount of tax and national insurance ?
The options outlined below incorporate the significant changes to the way that dividends are taxed and the restricted availability of the employment allowance which were introduced from 2016-17.
Assumptions – be aware of these:
- The suggested levels below are based on rates and thresholds as at today and prior to the budget announcement of the 22nd March
- It assumes no other income other than salary and dividend from your company
- No student loan and you have a standard personal allowance
- It assumes you operate outside of IR35
- Most importantly, the company has sufficient reserves to pay dividends after allowing for corporation tax of 20%
- The combination of the increased personal tax free allowance and basic rate tax threshold for 17-18 mean an additional £2k falls within basic rate tax of 20% rather than 40% giving an instant saving of £400.
- Income from savings is now tax free up to £1,000 (or £500 for higher rate tax payers) – saving £200 per year.
- Up to 10% of your personal allowance can be transferred to your spouse if they have some unused personal allowance – potential saving £230.
- Employee and employer NI thresholds are now aligned so costing and budgeting for employers will be a little bit easier!
- Salaries need to be below £10,000 to be ineligible for auto enrolment. This is important if your staging date is within the tax year 17-18.
- The employment allowance of £3k covers the cost of employer national insurance payable where there is more than one employee earning at or above £157 per week. Sole director companies or those where the second employee earns below this will therefore not be able to use this allowance.
Suggested options are below – do contact us should you have any further questions.
Option 1 – more than one employee, not yet staging for auto enrolment
Where there is more than one employee, the £3,000 employment allowance will be available which, for most clients will mean that directors can take the full £11,500 personal allowance and pay a small amount of employee NI (£400) which will be payable to HMRC over Jan – March 18.
Note that any other additional employees need to earn an annual salary of £8,164 or more to enable the employment allowance to be available to the employer.
Assuming you want to stay within the £45,000 tax threshold, this leaves £33,500 to be taken as dividends. The first £5,000 of this will be tax free using the new dividend personal allowance and the remaining £28,500 will be taxed at 7.5%.
Based on a gross income of £45,000, the total costs payable will be £400 of NI plus £2,137.50 of tax leaving £42,462.50 as net cash.
Summary: this equates to a monthly salary of £958 and dividends £2,790.
Option 2 – sole director or sole employee, staging has passed or upcoming or director has other income
As a sole director or sole employee, there is no employment allowance available. This means it is more efficient to reduce the salary to a level of £680 at which no employee or employer NI is payable.
At this level, earnings are not sufficient to trigger auto enrolment responsibilities. Sole directors can claim also exemption from auto enrolment. See our further article here.
The NI rate applicable on these earnings is charged at a rate of 0% which means that you still receive a full year’s NI credit to your state pension record even though no actual payments are made.
This option is also for you if you have other income such as rental profit, company benefits or other pension income which will use up the remaining part of your personal annual allowance of £3,340.
If you have no other income, the balance of £3,340 from your personal allowance of £11,500 can be used to pay dividends tax free. The next £5,000 of dividends will be covered as in option 1 by the new dividend personal allowance leaving the rest to be taxed at 7.5%.
Based on a gross income of £45,000, the total costs payable will be £2,137.50 of tax leaving £42,862.50 as net cash. Although this is a higher level of net cash than option 1, you lose £667 of corporation tax saving by having the lower salary going through as a company cost.
Summary: this equates to a monthly salary of £680 and dividends £3,070.
Which option is best for me?
In general, single company directors, those with other sources of income or those due to stage who want to make their own retirement provision will be using option 2.
NOTE : In determining the dividends payable each month, you will need to firstly ensure that the company has sufficient reserves after corporation tax (20%) to pay these. If this is not the case, then you will need to consider a remuneration (payroll) strategy to extract the funds you require from the business.
Payment annually or monthly?
We have the option of processing just one salary payment for you in March 18. The benefits of this are that you make just one payment of any NI owing to HMRC and avoid the potential number of PAYE coding changes in the year which usually result in an overpayment which is then withheld by HMRC for some considerable time.
Dividends can be taken for April 17 – February 18 with a salary payment only made in March 18.
We advise all clients to opt to pay their tax in one lump by the 31st January each year rather than request collection through coding.