You setup a company and you are working for your business. Sales are in and you are making a profit, but not seeing any benefit by working for yourself? It is almost as if you are an employee in someone else’s company.
It sounds like you are not aware of the various tax efficient ways of withdrawing money, so let me walk you through them.
If you setup a limited company, you and the company are considered two separate legal entities. This means that any transactions between you and the company need to be recorded in an account called“Director Loan Account” (DLA).
When you start, is very likely that the vast majority of business expenses incurred are self-funded. The transactions between you as a Director and the Company should be recorded in the DLA. This means when you have enough funds, you can withdraw the amount you put in, without incurring any Income Tax and NI.
However, we strongly recommend that you don’t get into a position where you owe the company money and the account becomes overdrawn. An overdrawn director’s loan account is where you,as a director, have taken money out of the company, that is not classed as a dividend or salary and the figure exceeds any money you have put into the company.
Having an overdrawn DLA can create additional tax liabilities and we recommend talking to your accountant about it.
The most common way of paying yourself is through PAYE. For this you will need to register with HMRC and depending on the level of income, pay Income tax and National Insurance contributions.
There are two National Insurance Contributions thresholds:
- Primary threshold is the point at which employees start paying NI - £9,500 for tax year 2020/21.
- Secondary threshold is the point at which employers start paying NI -£8,788 for tax year 2020/21.
Therefore, if you are a sole director, the optimum salary in 2020/21 is the lower threshold of £8,788 per annum. This is because a Sole Director cannot claim Employment Allowance, so setting the salary at this rate means they will not incur employer’s NI.However your salary will still contribute towards your entitlement to future state pension and benefits.
If there are 2 or more directors on the payroll, then they are entitled to claim Employment Allowance.This means each director can take a salary of £9,500 and will not incur any National Insurance.
The Income tax threshold is£12,500 for 2020/21, which means you can earn a monthly salary of £1,041.67 before you start paying Income tax.
Ok, so now you know how much you can take out in a tax efficient way but is this sufficient for your monthly outgoings?
Well, let’s look at the third option, dividends. These are payments made from the company’s profit (after you considered any Corporation Tax due) to its shareholder(s). The payments depend on the percentage each shareholder has in the company.
Dividends are tax free up to £2,000. Anything over this amount and up to £37,500 is taxed at 7.5%.
By taking a combination of a small salary and higher dividend payments, you could pay significantly less personal tax than you would as a sole trader and really see the benefit of working as a director in your own company.
Lastly, you can contribute into a pension and get 100% tax relief as an allowable expense. Your contributions are tax-free as long as the amount falls under the annual allowance of ¬£40,000 (2020/21 tax year).
Pension decisions are often complicated, and require careful consideration. We recommend speaking with a financial advisor for personalised advice before you make any contributions.
We acknowledge that the above might still be a bit too much information or it might not apply to you, as circumstances differ, but that is why we are here. So feel free to give us a ring and see if we can help.