One of the advantages of running your own business as a limited company is having the option of how you pay yourself, or extract money from the business for your own personal use. As the owner of a limited company you will be both a director and a shareholder. A director is an employee of the company and will receive a salary; whereas a shareholder is an investor and is therefore entitled to receive dividends where the company makes a profit. By using both methods to receive money from your company, you can reduce your tax liability because salary and dividends are charged at different rates. Not only that, but when you factor in corporation tax, it can be reduced dependent on the salary you take, however it cannot be reduced by dividend payments.
What are the tax rates for a director’s salary?
Receiving a salary from your own company is seen as income and will therefore be subject to the standard income tax rates. For the tax year 2018/19 they are as follows:
- Everyone has an allowance of earning up to £11,850 tax free
- 20% tax is applied to earnings between £11,851 and £46,350
- 40% tax is applied to earnings between £46,351 to £150,000
- 45% tax is applied to earnings over £150,000
- For anyone earning over £100,000 the personal tax allowance is reduced by £1 for every £2 over £100,000.
What are the tax rates for dividends?
Tax rates charged on dividends are lower than income tax rates to encourage people to support and invest in businesses. For the tax year 2018/19 they are as follows:
- The tax free allowance is £2,000
- 7.5% tax is applied to dividend payments between £2,001 and £34,500
- 32.5% tax is applied to dividend payments between £34,501 and £150,000
- 38.1% tax is applied to dividend payments of over £150,000
As you can see, it becomes clear that paying yourself through dividends is more tax efficient than paying yourself through a salary; however there are additional factors to consider when setting yourself a director’s salary.
What’s the best salary to pay myself as a director of my own company?
For the tax year 2018/19 we would suggest the following pay structure:
- Issue yourself a director’s salary of £8,424. This is below your personal tax allowance of £11,850 which means 100% of this income will be tax free.
- £8,424 is the optimum amount for a salary because it is within the National Insurance Primary Threshold. It means that you are not required to pay National Insurance Contributions (NIC), however it is sufficient to allow you to accrue a state pension allowance.
- The remaining £3,426 from your tax free personal allowance can be taken as dividends and this too will be 100% tax free.
- In addition, you are then entitled to a separate allowance of £2,000 for dividends which you should draw down from the company profits (your company must have sufficient profits in order to withdraw dividends).
- To attract the least possible amount of tax you can then take a further £20,150 in dividends (£34,000 which is the basic rate threshold, minus your personal tax allowance and dividend allowance). This will be taxed at 7.5% and you will need to pay £1,548.75.
What’s Employment Allowance (EA) and how does it affect how I pay myself?
EA is tax relief to help with the costs of NIC payments where a company has employees. It was first introduced in April 2014, and has since increased from £1,000 to £3,000 in April 2016. The tax relief is intended to support small businesses grow by enabling them to take on employees. EA is not available if you are the director of a company and have no other employees, however where you do have employees, you can adjust how you pay yourself in order to take advantage of the tax relief and save more on your overall tax liabilities.
Where you are eligible for EA, for the tax year 2018/19 we would suggest the following pay structure:
- Issue yourself a director’s salary of £11,850. This is the maximum from your personal tax allowance and so 100% of this income is tax free.
- This is over the National Insurance Primary Threshold so you will need to pay £411.12 in Employees’ NICs. The £472.79 Employer’s NIC you would also have to pay will be refunded via the EA scheme.
- Draw down £2,000 as dividends. This is the maximum from your dividend allowance and again, 100% of this will be tax free.
- You can take a further £20,150 in dividends (the same as above).
- You save £650.94 in corporation tax. This is calculated at 19% (corporation tax rate) of the difference between £11,850 and £8,424 (£3,426).
- Including the £411.12 you would have to pay for NIC mentioned above, you will save £239.82 more than the scenario above.
Remember, this option is only more beneficial where you are eligible for EA. Other factors which should be taken into consideration include other sources of income (if any), student loan repayments, pension contributions, potential IR35 implications and more.
For the most tax efficient way to extract money from your own limited company, make an appointment to speak to one of our accountants who will devise a strategic plan bespoke to your own circumstance.