As a director of a limited company, you have the option to decide how and when you extract funds from your company. There are a few different options available, and the route you choose will entirely depend upon your income and circumstances. However, most directors draw money out of their company in salary, dividends or a mixture of the two. We’ve put together a short article to help you discover which option may be beneficial for you.
Are your contracts inside or outside IR35?
One of the most important factors to consider when deciding how to draw income from your limited company is whether you are deemed inside or outside IR35. If you are inside IR35, all income must be processed as salary, and the tax deductions will be made before you receive payment. If you are outside IR53, you have the freedom to choose how you draw income from your company. For example, with a combination of salary and dividends.
Taking a salary from your limited company
As a director, there are several benefits of taking part of your income as salary via your limited company’s payroll.
The benefits of taking a salary from your limited company
- You can take a salary even if your business makes no profit
- You build up qualifying years towards your state pension
- You can make higher personal pension contributions
- You can reduce the amount of Corporation Tax that your limited company will pay as salary is classed as an allowable business expense
- It can be easier to apply for a mortgage, loan or insurance policy such as critical illness cover
- You can retain maternity benefits if your limited company employs you and is compliant with National Minimum Wage regulations
The drawbacks of taking a salary from your limited company
- A salary is subject to higher rates of income tax than dividends
- When you take a salary from your limited company, both you and the company may be required to pay NICs
Taking dividends as income
A dividend is a share of the company’s profits after all liabilities have been settled. Dividends are paid to shareholders and directors, and the amount they will receive will depend on the proportion of the shares they hold. There is no requirement to pay dividends, and a company can retain the profits or distribute them as required. Unlike PAYE salary, dividends are not liable for NICs or Income Tax deductions, making them an attractive option.
The benefits of taking dividends from your limited company
- You can significantly reduce your Income Tax bill by taking some of your income as dividends
- No employers or employees NICs are payable on dividends
- You have a tax-free dividend allowance which is in addition to your personal allowance
The drawbacks of taking dividends from your limited company
- Dividends can only be paid out of profits which means if your company does not make a profit, then you cannot be paid in dividends
- Dividend payouts are not a tax-deductible expense, unlike salary payments
- If you take a dividend payment that is not covered by the company’s profits, you will essentially have taken out a director’s loan, which you must repay
How are salary and dividends taxed?
Salary and dividends work in very different ways. Salary is liable for NICs and Income Tax, which will be deducted from your earnings. Please be aware that the amount due will depend on how much you draw as salary. The Income Tax thresholds for salary for the 2021/22 tax year are as follows:
|Tax Band||Taxable Income|
|Personal Allowance||£12,570 per year|
|Basic Rate||20% on earnings above the threshold and up to £37,700|
|Higher Rate||40% on earnings between £37,701 and £150,000|
|Additional Rate||45% on earnings above £150,000|
Dividends are taxed slightly differently as they are not liable for Income Tax or NICs. The dividend tax allowances and thresholds for the 2021/22 tax year are as follows:
|Tax Band||Tax Allowance|
|Basic Rate||7.5% on taxable income over the Personal Allowance up to £37,700|
|Higher Rate||32.5% on taxable income between £37,701 and £150,000|
|Additional Rate||38.1% on taxable income above £150,000|
Should I pay myself a salary, dividends or both?
Ultimately, deciding whether to pay yourself dividends or a salary or both will depend on your circumstances, the tax bracket you fall into, and your income. Most limited company directors find that the most tax-efficient way to operate is to pay themselves a salary up to the tax-free allowance and receive the rest of their income via dividends.
Are you considering setting up a limited company?
Churchill Knight & Associates Ltd has a range of limited company accountancy services, including business tax planning and advice tailored to your circumstances. Our expert team will assist in the formation of your limited company and provide you with professional advice to ensure you’re paying yourself in the most tax-efficient way.