There are a number of ways you can structure your company, including sole trader, partnership, and limited company for example. For people who choose to structure their business as a Limited Company, there are different options available when wanting to pay themselves. If you are a director and shareholder of your company you can choose to pay yourself a salary, take money in the form of dividends or a mixture of the two, depending on the IR35 status of any contracts. Since these levels will depend upon your other income and your own personal circumstances, the best way will be unique to you and your company.
To help you decide the most tax efficient structure for you and your company, we’ve put together some advice.
What are dividends?
Dividends are distributions of profit to shareholders and, along with salary are a way of extracting funds from your company. Provided that your company has the profit to do so, you can declare dividends as and when you wish, although there is an argument that doing so on a monthly basis gives the impression that these are being treated as an equivalent to employment income rather than as a return on investment.
You can find more information in our comprehensive guide.
How are salary and dividends taxed?
Income is taxed in the order of non-savings income, savings income and finally dividends.
Salaries are then taxed first and utilise some or all of your personal allowance and National Insurance thresholds. Any salaries above these would then be subject to Income Tax at your applicable rate (20%/40%/45%) and employees National Insurance at 8% at the basic rate and 2% above the Upper Earnings Level. Your company would also be subject to employers National insurance on any salaries above £5,000.
Dividends however are taxed somewhat differently. The first £500 of dividend income over and above the personal allowance and then you pay Income Tax at 10.75% at the basic rate of tax, 35.75% at the higher rate and 39.35% at the additional rate. As well as being lower than the main rates of Income Tax, crucially you do not pay National Insurance on dividend income.
Should I pay myself a salary or dividends?
The most efficient method of extracting money from the company will depend on a number of factors; if you have other (e.g. rental) taxable income or had employment income prior to forming your company for example.
For directors whose only source of income is via the company however, generally speaking, taking a salary below or up to the personal allowance and declaring dividends above this will be the most tax efficient method.
Utilising a tax efficient structure
Although, ordinarily, giving shares to someone else would give rise to a tax liability for either the gifter or the recipient, there is an important exception. Gifts between spouses or civil partners are not taxable and it has been established in case law that this extends to the gift of shares in a close company.
If then your spouse or civil partner is not fully utilising their basic rate tax band, gifting a proportion of your shareholding would entitle them to an equivalent proportion of any dividends declared, thus enabling them to more fully use their basic rate band and extract further dividends from the company.
Have any questions about the best way to take money out of your company? Get in touch to find out how we can help you.