Tax efficient profit extraction from a Ltd Company
It’s that time of year again when directors of UK family owned companies will be considering the most tax efficient method of paying themselves. So, with the new tax bands for 2019/2020, what combination of salary and dividends will be most effective for you?
Please note that this blog assumes you are NOT a Scottish tax payer as Scotland has different rates of income tax for non-savings income (salary).
It’s common practice, and tax efficient for directors and shareholders to take a low basic salary, and then extract the remainder of their income as a dividend from any retained profits, as the income tax rate on salary income is lower than the current dividend income tax rate.
The salary should be high enough for National Insurance (NI) purposes so that it counts as a qualifying year for State Pension purposes (above £6,136 for 2019/2020). The salary (unlike dividends) is also an allowable cost for Corporation Tax so 19% Corporation Tax is saved on the gross salary amount.
The dividend allowance for 2019/20 remains at £2,000. You won’t pay any tax if you have unused personal allowance which covers your additional dividend.
Any dividends falling within the basic rate band (up to £50,000) will be taxed at 7.5%, dividends in excess of the basic rate band will be taxed at 32.5%. Any dividends that then fall within the additional rate band (income over £150,000 form 2019/20) will be taxed at the higher rate of 38.1%.
Q – What is the ‘optimum’ level of salary and dividends?
A – It depends!
Is the £3,000 Employment Allowance available (where the sole director is not the only employee), and not already been fully utilised against NIC’s on staff wages?
NO – Then an annual gross salary of £8,632 will not attract income tax, nor NI, but it will count as qualifying earnings for State Pension purposes. To avoid paying Higher Rate Tax (on income over £50,000), then dividends of £41,368 (£50,000 – £8,632) should be paid, providing the company has sufficient reserves.
The total income extraction would be £8,632 salary and £41,368 dividends. The income tax liability (assuming basic personal allowance and no other income) would be £2,663. You would have a net income of £47,337 after tax.
YES – Then an annual gross salary of £12,500 (Personal allowance for 2019/2020) should be paid.
This level of salary will not create an income tax charge, but it will create an employee’s NI charge of £464 (assuming NI letter A). No employers NI will be due as it will all be covered by the Employment Allowance (assuming that it has not been utilised against other employees NI charges).
If you have other employees, then you will need to consider if their salaries already use up the annual Employment Allowance.
To avoid paying Higher Rate Tax (on income over £50,000), then dividends of £37,500 (£50,000 – £12,500) should be paid, providing the company has sufficient reserves.
The total income extraction would be £12,500 salary and £37,500 dividends. The income tax liability on the dividends (assuming basic personal allowance and no other income) would be £2,663.
The total income extraction would be £12,500 salary and £37,500 dividends. The income tax and NI liability (assuming basic personal allowance and no other income) would be £3,127. You would have a net income of £46,873 after tax.
The additional salary would save Corporation Tax of £735 (19% on the £3,868 extra salary), and cost employees NIC of £464, an overall saving £271.
Contact us to discuss other tax efficient ways to extract profits from your family owned company.
Figure Fairy Ltd – Bodmin based accountants serving small and medium sized businesses in Bodmin and across Cornwall. If you’re in need of a new accountant with a refreshing approach to client relations and small business solutions, get in touch today on 01208 369972 or email us at info@figurefairy.com