If you are a sole trader or a partner in a limited company, you might be looking for the most efficient ways to pay yourself in the UK. Paying yourself as an owner of a limited company can become inefficient in terms of tax if you overlook essential taxation features in the UK. Withdrawing money from your business as a part of your salary, dividend, or a director’s loan is affected by certain actors. For example, personal allowance, dividend allowance, state pension, and NICs affect the decision. So, making decisions by calculating all these components is essential to get to the most efficient ways.
This article will walk you through the most efficient ways to pay yourself as an owner or director of a limited company. Moreover, we will discuss the benefits of using each mentioned method to help you decide which tax strategy is most suitable. So, let’s start!
Paying yourself as a limited company owner might become confusing. But, AccountingFirms can help you by providing you assistance in your tax management.
Tax Advantages of a Low Salary
The employees or the owners are paid through PAYE. Thus, taxes are already deducted from the salary through the payrolls. These salaries are part of the deductible expenses. So, they can lower the Corporation Tax bill of the company.
Three factors can help you decide the best salary amount to draw from your organisation as an owner:
- Personal Allowance of £12, 570.
- Lower Earning Limit of £6,396 to qualify for the state benefits.
- Evade the National Insurance Contributions (NICs) if your salary is below the limit of £8,632.
- Employment Allowance of £5,000.
Moreover, the NICs are also affected by the decision to take a salary. If you take out your money as a salary, you are entitled to a personal allowance of £12 570.
On the other hand, the lower earnings limit for the NICs is £6,396, and the Primary threshold is £11,908 for 2022/23. The purpose is to keep your salary below the primary threshold to avoid paying NICs. You will pay a Class 1 National Insurance Contribution on the primary threshold.
However, you will not pay any income tax or NICs on the Secondary threshold of £9,100. Moreover, you can also enjoy the employment benefits if your Class 1 NICs liabilities were lower than the £100,000 in the previous tax year. Employment allowance allows the employers to claim up to £5,000 and can reduce their NICs by this amount.
So, you must set a salary between the lower earnings limit and the personal allowance to take advantage of all these advantages mentioned above.
Tax Advantages of a Higher Salary
A higher salary also gives you certain tax benefits and other advantages. For example, if you wish to take out a loan or mortgage from a bank, you can take out a higher salary from your company. Besides, you can take out a higher salary being a female owner of a limited company and enjoy the maternity benefits with your paycheck. For this, you must qualify for at least 16 weeks of paying NICs out of 66 weeks.
Dividends
The dividends are not part of an employee’s salary. So, they are not deductible expenses. As a result, they do not affect the Corporation Tax bill. Moreover, the dividend rates are lower than the Capital Gains Taxes. So, if you want to pay dividends, you can enjoy a dividend allowance of £12 570. This dividend amount is tax-free.
Dividends are not paid PAYE. They are born out of profits. So, the company has already paid tax on them. So, the rates payable on dividends are lower comparatively. On the other hand, the tax on dividends is also affected by the tax bracket of a shareholder.
Director’s Loan
Director’s loans also provide tax-free funds without affecting the corporation tax bill. Director’s loans are worked out the other way round, where the owner or director lends money to the company to compensate for the short-term cash problems. Using this strategy can cost you a penalty by the HMRC. So, it is advised to use a director’s loan if you really need funds only. On the other hand, an accurate record of this loan and the on-time repayment can only save you taxes. Otherwise, you have to pay income tax as well as corporation tax.
Pension Funds
Another tax-efficient strategy is to deposit all the profits into a pension fund. Pension funds provide exemption on the NICs, income taxes, and Corporation Taxes. So, if you put all your company’s funds into pension funds, you can enjoy the most efficient taxation.
You can do this only if your annual allowance for tax-free pension contributions is less than £40,000. Moreover, 25% of the pension fund is tax-free, and you can withdraw it without paying any tax.
Final Thoughts
The bottom line is getting a lower salary with a combination of dividends is the best strategy that works out for most of the directors and the owners of a limited company. On the other hand, you must not ignore the tax benefits and allowable expenses while deciding on the higher salary deductions.
Deducting your salary from your company becomes necessary to carry out and manage your expenses. But, if you take out money without considering the tax benefits and corporation tax working, you are likely to pay higher tax rates comparatively.
Lastly, you must be careful about this as you are probably paying double taxes, and you need to maintain a proper record of your taxes and income. Moreover, you can seek from tax advisors and professionals in personal income taxes.
AccountingFirms provide you with tax advisory services and other related services. check out our bespoke services to help you get the most out of your taxes without any compliance issues. Get in touch with us.
Disclaimer: All the information provided in this article on the most tax efficient way to pay yourself, including all the texts and graphics, is general in nature. It does not intend to disregard any of the professional advice.