How should a business owner pay themselves?
This is one of the key questions that we help clients to answer.
The basic answer is take a salary upto the limit before NIC kicks in, which is approximately £8,000. Then take dividends upto the basic rate band, this changes every year but is approximately £45,000.
So thats £8,000 salary + £37,000 dividends = £45,000 total income, and the income tax will only be approximately £2,000.
The above plan will avoid tax/NI on salaries, but the company saves corporation tax on the salary. The dividends will be partly tax free and partly taxed at 7.5%, which is very low.
If your total income exceeds the basic rate (currently £45k), then you’ll have to pay tax at 32.5% on the excess.
To be honest, the level of salary/dividends really depends on the circumstances and goals of the business owners:
- do you have directors loans
- do you have any other income? eg from property or another/previous job
- are you able to share the dividends with family members?
- do you want to defer tax as much as possible?
- do you need to show a certain income? eg to apply for a mortgage
Also, we would need to make sure your company has enough profits after tax to pay the dividends. We would also ensure that they are properly documented (board minutes/dividend certificate) and declared in your personal tax return to HMRC.
If you’ve invested money into the business, then the company can repay this loan to you without any personal income tax.
If you owe the company, you can repay this using dividends instead of physically transferring cash into the business. But you’ll have to pay income tax on the dividends.
What do most clients do?
The advice that we give to the vast majority of our clients is take out enough money to meet their needs, but to leave money in the business if they don’t need it. This is because it avoids unnecessary personal tax on dividends and the business can re-invest it for example on marketing or property (or put it into a pension).
If you recently started your business and left your old job, it may not make sense to take a salary/dividend in the first tax year because you may have already used up your free/low tax allowances due to your previous job. For example, if you already earned £50,000 in the tax year, then salary/dividends would be taxed at the higher rate. Waiting until the next tax year to take out salary/dividends would reduce your tax bill significantly.
Similarly, if you have rental income from properties that you own, then you can reduce your dividends by the rental profit, in order to avoid paying tax at the higher rate 32.5%.
If there is one spouse/partner not working, you can split your company ownership 50:50 and you can both take dividends (if you’re not married, there may be some tax implications on transferring shares).
If the spouse/partner can work as a director, then they can also receive a salary, but care should be taken to ensure that they actually do some work and there is a paper trail to prove this.
If you have adult children, it may also be possible to give them shares/salary.
It may be possible to defer dividends using directors loans but there are some strict criteria that HMRC require for this.
Some clients will prefer to pay tax as soon as they can on money they’ve taken out, so that they don’t have to worry about paying a bit tax bill later.
But most clients prefer to defer their tax bills as far away in the future as possible, so that they can spend it on their business or personal needs. We can create a plan on how to take out dividends each year and help you to save the tax so that you have it ready when you need to pay HMRC.
Speak to a mortgage broker who specialises in self employed business owners, but if you’re applying (or renewing) for a mortgage, generally you’ll need to show 2 or 3 years of company accounts and also personal tax returns. These will normally have to show that your company made a profit and then you took out the money as dividends, and declared this to HMRC.
If you leave profits in the business and you’ve built up a pile of cash then you can close the business and only pay 10% tax on the profits left in the business. This is because they’ll be taxed as capital gains and you’ll benefit from entrepreneurs relief if you’re eligible (subject to certain limits/exclusions eg property companies can’t claim it).
But this will require a formal liquidation if the profits/reserves exceed £25,000.