03 July 2017
As a company director, you’ve taken on the risks of setting up and running a limited company, plus the hard work of ensuring the business turns a profit. But how do you make sure you get paid in the most efficient way once the profits do start rolling in?
Putting you and your fellow directors on the payroll with a full salary isn’t very tax efficient, and will also eat into your cash reserves. Paying year-end dividends, taking a loan from the company, sorting out pensions payments and other benefits and payouts all have to be taken in consideration – and that can begin to get complicated.
So here’s our guide to the simplest, and most beneficial, ways of paying yourself as a director.
One option is pay yourself a ‘living wage’ each month from your company’s normal payroll run. This gives you a regular income from the business, and should be based around a budgeted amount that covers your average monthly outgoings.
A downside of this approach is that you’ll be paying PAYE income tax and National Insurance Contributions (NIC) on this monthly salary. Depending on the amount paid, you could end up paying as much as 45% (the top rate of income tax) on this living wage – making it a far from tax-efficient way of paying yourself.
One way to combat this inefficiency is to pay yourself an amount that covers the current NI threshold, making what you earn tax free. This threshold currently stands at £8,424 per year, meaning you could earn £702 per month in this way without any PAYE or NIC.
It’s worth noting that you can pay yourself a wage as a director and still qualify in later life for the state pension. Directors will usually do this by keeping their direct wage below £8k per annum – there’s more about the income threshold for director’s here.
Dividends are paid to shareholders when the business makes profit. And because you pay tax on the profit through your corporation tax (currently 20%), they’re usually a more efficient way than PAYE to take money out of the business and put it in your pocket.
The current £2,000 dividend allowance makes dividends a less attractive option for you as a director than in previous tax years. If you’re earning over the new £2k allowance, you could be taxed as much as 38.1% on that income – and this is on top of the 20% you’ve already had taxed on your profits!
You’ll pay tax on dividends you receive over £2,000 at the following new rates:
So, what should you do? There are other options outside of dividend payments, including paying into ISAs or pension schemes, but you’ll need to do some quite complex tax planning to make this work efficiently (come and talk to us if you do find yourself in this boat).
Dividends are only payable out of post-tax profits. So if you’re not yet turning a profit and need to take out funds, you’ll have to do this via a salary not dividends.
The same level of dividend must be taken by all your shareholders of the same share class, unless you’ve made a specific agreement for certain shareholders to waver their dividends. This is something to think about if you have some shareholders who run the company and some who aren’t actively involved. This is particularly relevant if you’re looking to raise venture capital investment.
If your business is carrying out research and development (R&D) qualifying activities then you’re better off paying your directors via a salary than dividends. Only payroll salaries are considered in an R&D claim, not dividends, so paying salaries will increase the scope of your claim.
PAYE and dividends are not the only considerations when looking at your income as a company director. There are plenty of other areas which you’re likely to need some professional advice on, so we’ve highlighted a few of the more common things you’re going to need to take into account when it comes to directors’ income.
It’s a very good idea to take out a pension plan, as this can be a tax efficient way to take money out of the business while also investing in your own long-term financial security.
Making contributions from the company into your personal pension scheme helps to build a nest egg for retirement. But you also have to the option to ‘draw down’ up to 25% of your pension pot tax free once you reach 55 years of age. You may also have to pay income tax on your pensions contributions if the overall size of your pension pot exceeds £40k in the year.
It’s possible that you’ll want to borrow money from the company in the short term in the form of a loan. It’s a fast way to get access to money, but will also mean you have to record details of the money loaned, the payments repaid – and also pay tax on this loan.
You’ll need to set up a director’s loan account, which accounts for the money you’ve taken out and the money you’ve paid back to the business.
Depending on the circumstances of the loan, and whether you’re paying interest on the amount owed, you may also need to pay income tax (at 20%) on these repayments and fill out form CT61 with HMRC. There’s more info on the HMRC site here.
Benefits you claim from the company will need to be accounted for and may affect your tax code and the amount of income tax you pay.
For example, if you have a company car, this is classed as a benefit. This means the company will have to pay NICs at 13.8% and you’ll need to declare the benefit on a P11D form and pay NICs on this benefit too.
It makes a lot more sense to own your car yourself and then charge your business miles at 45p per mile – you can claim this up to 10,000 annual mileage, and then at 25p per mile thereafter. The Tripcatcher app makes recording your mileage really easy and uploads your journeys seamlessly into your accounts (making your tax return much easier to complete).
Other considerations to think about could include:
Director’s pay can be a complex thing to get your head around. But with the right guidance, planning and forward-thinking, you can very easily set up an effective, tax-efficient way to earn money from your limited company.
As with most things in business, it’s about identifying the challenges, planning ahead and talking to a professional adviser.
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