Directors of a limited company have a choice of how to take the profit out of their business. Finding the best way of remuneration can depend on the company’s profits, the tax implications and any benefits you want to retain.
Most directors take a mix of salary and dividends, supplemented by pension contributions from the company. Let’s take a look at the different options.
Pros and cons of taking a salary
It’s often a good idea for a director to take a small salary from the company’s payroll, even if it makes no profit. This enables you to build up qualifying years for a state pension and make higher personal pension contributions. You retain maternity benefits and it helps with applying for mortgages and insurance cover. As salary is an allowable business expense, the company’s corporation tax is also reduced.
The main disadvantage of taking a salary is that you and the company are liable for National Insurance Contributions (NICs) and the higher level of income tax that a salary draws.
How much salary to take?
The personal allowance for income tax on earnings is £12,570 for the 2022/23 tax year and employee NICs will apply after this threshold too, whereas employers NICs are payable on earnings above £9,100. It works for some directors to set their salary between the Lower Earnings Limit for NICs (£6,396) and the Primary Threshold to be able to build up qualifying state pension years but avoid paying NICs. Equally, the Employment Allowance may be available to offset employer NIC, but not if the director is the sole paid earner.
Pros and cons of taking a dividend
Dividends are a tax-efficient way of taking an income from your business. A dividend is a share of the company’s profits and are paid to directors and other shareholders depending on the shares they hold. No employer or employee NICs are payable on dividends.
The disadvantage of dividends is that they can only be paid from profits after taxes and as they are dependent on profit levels, they can be unreliable. Dividends are not classed as ‘relevant UK earnings’, so they don’t count for computing the maximum tax relief on pension contributions that you make yourself.
Dividend allowance
In addition to your personal allowance, there is a tax-free dividend allowance of £2,000 in the 2022/23 tax year, meaning you can earn up to £14,570 before paying income tax. The dividend allowance will reduce to £1,000 for the tax year 2023/24 and the tax rate on company dividends will be 8.75% for lower rate, 33.5% for higher rate or 39.35% for additional rate taxpayers.
Extracting profit in other ways
With the guidance of an experienced accountant, these alternative methods of extracting profit may work for you:
- Interest paid on money loaned to the company is not subject to NICs, as long as you comply with the rules and regulations.
- £6 per week plus can be claimed from rental of a home office, or the landlord/director can grant a licence to the company. Paying rent to the director reduces the company’s tax liability as it is an allowable expense but is taxable via the director’s personal tax return.
- Making company pension contributions is an allowable business expense, saving up to 26.5% in corporation tax (for companies with profits in the marginal rate band from April 2023). The contributions are not liable for employer NICs and are not limited by the size of your salary, but they can’t be accessed until the age of 55 at the earliest.
Whichever method you choose to take an income from your business, good accounting practices and advice is essential. Talk to the friendly experts at CRM about the most tax-efficient ways to extract profit on 01865 379272.
