Making your business as tax efficient as possible is key to maximising profits and delivering investment for growth. From income tax to national insurance contributions and corporation tax, there is a lot to take into account when running any limited company.
The most common way to take out money from a company is through a salary paid every month. But company directors can also benefit from some completely legal and more tax-efficient ways to extract profits including through dividend payments, loans and pension contributions.
All money that is taken out of a company needs to be recorded and legally accounted for. Getting the right mix for your company directors will depend on a variety of things and it can be useful to discuss ideas with a qualified accountancy team.
Here we look at a range of ways you can legally take money out of a limited company and how splitting your income between the different options available can be more tax efficient.
How do I legally take money out of a limited company?
As a company director there are 5 legal ways that you can take money out of a limited company and how you do this will define how tax efficient your approach is.
These include:
- Dividend payments.
- A standard salary.
- Company bonuses.
- A director’s loan.
- Pension contributions.
Dividends
If you are a director of a limited company, you will have access to shares that release dividends from the business and you will be able to draw on these at certain times.
Once salaries and tax liabilities have been paid, the profits from your company can be divided between directors and shareholders in the form of dividends.
These are generally one-off payments that are issued at the end of the financial year. The amount given depends on the percentage of the company that an individual owns or has invested their money in.
Larger companies may well issue dividends at several points throughout the year depending on performance and how much this is will dictate whether you will be paying tax on the income.
A dividend needs to be agreed at a board meeting which will decide the amount to be paid and the date that payment will be issued to the company directors or shareholders. This is a useful and tax efficient way to get paid for directors.
In short, the first £2,000 of your dividends is tax free. Above this, there is a dividend tax. The lower rate is 8.75% and the higher rate is 33.75%, depending on the size of the dividend.
For example, if you have a salary of £25,000 you will pay the normal income tax and national insurance as an employee. If you are given £5,000 in dividends, you will not pay tax on the first £2,000 and just 8.75% on the remaining £3,000 (as opposed to the basic income tax rate of 20% if that amount was taken as salary).
Salary
The most common way to take money out of a business legally is through a salary which is paid into your personal bank account.
You pay the normal income tax depending on the amount you ‘earn’ along with employers’ national insurance contributions:
- Up to £12,500, you will pay no income tax and between £12,501 and £50,000 you will pay the basic rate of income tax of 20%.
- Class 1 National Insurance contributions kick in when you earn more than £823 a month and are charged at a rate of 13.25% on all income above this level (up to a maximum of £4,189 when the rate reduces to 3.25%).
Bonuses
Companies will often issue bonuses to directors as a reward because the business has been good. Bonuses are considered as part of the salary so you will need to pay the appropriate tax and national insurance according to your personal allowance and tax obligation.
If you decide to take a non-cash payment, such as a car, these may be subject to different rules and less taxation.
Directors Loans
Another way to legally take money out of a limited company’s balance sheet is to receive it as a director’s loan but this can cause difficulties if not handled properly. All transactions of this type need to be recorded and have to be transparent.
A director’s loan is a low cost way to take money out of the business but is generally a short-term solution and needs to be repaid ideally before the end of the financial year.
If the sum is over £10,000, it is considered income and you may need to pay tax particularly if it is not paid back within a certain timeline.
Pension contributions
Finally, the other way to take income out of the company is through pension fund contributions.
If you are earning up to £150,000 you have a personal allowance of £40,000 a year you can invest into your pension fund but you will not be able to access the money until your retirement date.
Will taxation affect these withdrawals from the company?
While there is no way to take money legally out of the company profits that is entirely tax free, getting the right balance between the approaches above can help reduce your tax liabilities over the long-term.
For example, if you earn over £50,000 as a company director, taking money over the threshold in dividends can reduce your tax liability significantly.
Frequently Asked Questions
Do dividends reduce corporation tax?
No. Dividends are issued from the company’s profits after things like corporation tax have been calculated and paid.
Is it better to pay yourself a salary or dividends?
A lot will depend on the size of your salary and the amount of dividends that can be paid but, in general, a mix of salary and dividends can be more tax efficient.
Can Corporation Tax be written off?
Corporate tax relief is available on costs that you incur while running your business. These include capital allowances such as investment in equipment or currently allowed areas of relief such as research and development.
Conclusion
Choosing the best mix for your business when it comes to taking money out legally and more tax efficiently can be challenging.
In general, a mix of the above solutions allow you to reduce your tax liability while not completely writing it off. Working with a team of qualified accountants can help you make the right choices.
Want to discover how to make your business more tax efficient? Contact the expert team at VW Taxation today.
