Once you incorporate your business as a limited company, it becomes its own separate entity. This means it is not an extension of you, as would be the case with a sole trader business, but rather it has its own legal standing. This comes with a host of benefits, the main one being limited liability. This means that should your company find itself in debt, you as director cannot be held personally liable for the outstanding money.
However, there are some drawbacks too.
One of these is when it comes to extracting money from the business for your own personal use. As it is its own entity, your company’s bank account is not yours; you cannot simply take money from it as and when you choose.
However the good news is that there are various ways of taking money out of your limited company in a legal manner. Here are the three main methods utilised:
Salary – This involves registering as an employee with HMRC and having your salary paid through the PAYE system. This can be an extremely tax-efficient way of extracting money from your company, as done correctly, this can minimise deductions while still making you eligible for state benefits including the state pension. The key here is how much you choose to take as a salary.
There are two main tactics employed by company directors who are looking to keep tax deductions to a minimum:
- Take a salary up to the National Insurance Contributions (NIC) threshold which currently stands at £8,632 (2019-20). This means no Income Tax or NIC will have to be paid, but eligibility for the state pension will remain as this amount is above the Lower Earnings Limit of £6,136/year.
- A salary equivalent to the personal allowance level of £12,500 (2019-20). At this level, income tax will not need to be paid; however, Class 1 National Insurance of 12% will need to be deducted from the salary falling between £8,632 and £12,500.
Dividends – Once a company is making a profit, this money can be left in the company to be reinvested in the business and its operations, or this can be taken out by way of dividends in order to provide you with an income. Dividends can be only be taken from the company’s profits once deductions for corporation tax have been taken into account. Dividend payments must be from retained profits; should they be taken when the company is not showing a profit these will be classed as illegal dividends and could lead to penalties or an investigation by HMRC.
Dividends can be paid at the end of the year, or interim dividends can be made throughout the year in instalments. This option is often preferred by small businesses in order to provide directors with a regular source of income. Although tax will have to be paid on dividends, the rates are much lower than for a regular salary, making them an attractive proposition for directors looking to minimise their tax liability.
Individuals are given an annual dividend allowance of £2,000, however, dividends above this amount will be subject to tax. For the 2019/20 tax year, the rates are as follows:
- 7.5% for basic rate taxpayers
- 32.5% for higher rate taxpayers
- 38.1% for additional rate taxpayers
Before dividends are taken, this must be declared at a board meeting and minutes of this meeting taken and kept at the business’s registered address. This process must be completed even if the company only has one director. A dividend amount is declared and this is distributed amongst shareholders depending on their percentage shareholding.
Director’s loan – A director’s loan is a two-way street, being a way for the company to borrow money from a director, and also for a director to borrow money from a company. All debits and credits must be accurately recorded and these figures must be reflected in the company’s balance sheet.
In the vast majority of cases, no tax will have to be paid on overdrawn loan accounts if the money is repaid in full within 9 months and 1 day of the company’s account reference date (ARD). Should it remain outstanding, Section 455 Tax (currently 25%) will be charged, and be paid by the company alongside its corporation tax. This will be reimbursed once the loan has been paid back.
If the loan is written off by the company, this needs to be declared on the director’s Self Assessment tax return so that the correct rate of income tax can be levied.
It is often the case that a combination of these methods results in the most tax-efficient extraction of funds. Knowing how best to take money from your company can be complicated, and the implications of doing this wrong could have serious ramifications not only financially, but also on you personally as a director.
An accountant will not only be able to help you structure your income in the most tax-efficient way possible, but will also ensure you are adhering to your obligations as director. If you need help finding an accountant in your local area to support your small business, Handpicked Accountants can steer you in the right direction. As we only recommend accountants we have personally worked with, you can trust us to put you in touch with a knowledgeable and reliable accountant who can be depended upon to do a good job and for a fair price. Start your search for your perfect accountant today.