Registering as a limited company can be beneficial on many fronts for your fledgling business, but when it comes to paying yourself, owning a limited company can seem a little more complicated. Here at Valued, we want to help you understand your options on drawing money from your business in the most tax-efficient ways.
How to pay yourself as a limited company owner
As a limited company owner, there are several ways to pay yourself from your business. Below we go into detail about how and when taxation will affect your choices.
1. Salary (two or more shareholders)
Limited companies with two or more employees pay salaries via HMRC’s PAYE scheme, company directors will become part of this scheme. Personal allowances apply to PAYE taxation, so you will need to consider the tax threshold is currently £12,570, meaning anything thereafter is to be taxed. For salaries between £12,570 and £50,270, a tax rate of 20% applies and from £50,270 and £150,000 tax is 40%. Anything over £150,000 has a taxation rate of 45%.
Salaries can also be marked as a business expense, which helps reduce your overall business Corporation Tax.
On top of income tax, you will be required to pay your personal National Insurance through your wage. The Primary Threshold is £9,880 for the first 3 months of the tax year, and £12,570 for the final 9 months. Taxation starts at 13.25% between £11,908* and £50,270 per year. You will have to remember that as an employer you will also have to make National Insurance contributions, even on your own pay. Class 1 starts at 15.05% on salaries over £9,100.
Whilst it seems logical to draw less salary from your limited company as a director, it is important to remember that you must keep your base rate of salary pay above the Government’s lower-earning limit of £6,396 per year in order to claim entitlement to your state pension, or any future state benefits. So to be the most tax-efficient you should consider paying yourself a salary of around £12,570.
There is one allowance to take note of when working in a limited company and optimising your salary payments and that is the Employment Allowance. Employment Allowance was set up in 2014 as a benefit to certain employers of around £5,000 in National Insurance liability. This can only be claimed against your total spend on Class 1 National Insurance (NI). To meet the criteria you will need to be a business or charity that spent less than £100,000 on NI contributions, which were above the secondary threshold of £9,100 for individual employees, in the previous tax year.
Taking advantage of your salary options could help you reduce your overall Corporation Tax bill, which you will need to pay as a limited company.
2. Salary (sole shareholder)
As a sole director of a limited company, you will not be entitled to the Employment Allowance, therefore it is good practice to take a salary up to the primary income tax threshold of £12,570 and remunerate the rest with dividends. Tax figures and thresholds are exactly the same.
NI contributions remain in place as they would for sole traders, at which the thresholds are £9,880 for the first 3 months of the tax year, and £12,570 for the final 9 months.
Choosing to reduce your salary outlay and remunerating yourself as a director with shares is a wise choice when it comes to taxation in general.
Limited company directors are able to draw dividends from the business profits after Corporation Tax has been paid. The allowance before taxation is due is currently £2,000. The rate of tax thereafter depends on your tax band, where a basic rate is 8.75% (£12,571 to £50,270), the higher rate is 33.75% (£50,271 to £150,000) and additional income (over £150,000) is taxed at 39.35%.
At this lower rate of taxation (even lower than marking your salary as a business expense, something you cannot do with dividends), it is much more prudent to draw money from your limited company in dividends over a traditional salary once you meet the base threshold, because your income tax limit rises from £12,570 to £14,570.
One thing that business owners in this position need to remember is that dividends can only be paid from your profits, so you need to make sure that your business is profitable year on year.
Dividends are also paid based on your share value, so if you own 20% of your limited company, then you are entitled to dividends of up to 20% in profits. A key point to make here is that no business should exhaust its profits from year to year in dividend payments. A healthy business always needs a reserve in capital to invest in growth, restructuring and staff, or assist monthly cash flow across the year.
As a limited company, you are able to make pension contributions for all of your employees, including shareholders. The current annual allowance for tax-free pension contributions is £40,000 per year. Pension pots can be drawn by those over the age of 55 and any amount taken is tax-free on the first 25% (in most cases).
Pension pots should not be considered free money each year, instead, they are investments for future payouts. You should, therefore, have a clear idea of what you need financially to uphold your daily life today and consider salary and dividend payments, before large-scale pension investment as a way to earn money from your business.
5. Director’s Loans
Under the law, any company director can take funds from the business for a limited time without paying any tax (in most cases), through a Director’s Loan. Strict records of such transactions must be kept, including details of repayment structures and deadlines. If you fail to repay company loans on time, then taxes may be levied by the government through your corporation and income taxes.
Continued use of this method of personal finance is frowned upon as tax avoidance and will see taxes levied on all future directorial loans by HMRC. Our advice is to make sure you have a clear need for funding in this way and only take Director Loans when a salary or larger dividend payment may not be an option.
6. Benefits and expenses
Company directors often make use of benefits and expenses as a way to further their income from the business. These may include:
- Retirement schemes
- Computers and office equipment
- Training costs
- Company cars
- Fuel expenses (mileage allowances) and parking charges
- Health care and medical insurance
- Travel expenses, meals, and entertainment expenses
The Government’s A-Z of expenses glossary will give you a greater understanding of the taxation required for each benefit or expense.
What you need to do before your structure your pay
We have broadly discussed many options here and understand it can feel overwhelming to have to make a financial decision on your own. We recommend speaking to a financial advisor, such as one of our expert team members in order to help you make the right choice for your financial freedom. We are here to help you understand your business finances and obligations, so call us today!
Disclaimer: As a limited company owner it is crucial that you seek expert advice from your accounting council, with regard to the correct way to manage your business finances and pay. Individual cases will need individual advice. Therefore for these reasons please consider this article a guide to the options available, from which you can seek expert advice from an accountant.