Happy New Tax Year!

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.

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 dividend income is lower than the current income tax rate on salary income. 

The salary should be high enough for National Insurance (NI) purposes so that it counts as a qualifying year for State Pension purposes (above £8,840 for 2021/2022).  The salary (unlike dividends) is also an allowable cost for Corporation Tax so 19% Corporation Tax is saved on the gross salary amount.

Q – What is the ‘optimum’ level of salary and dividends?

A – It depends!

Is the £4,000 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 up to the Employer’s National Insurance Threshold for 2021/22 of £8,840 should be paid.  This 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 £50,270), then dividends of £41,430 (£50,270 – £8,840) should be paid, providing the company has sufficient reserves. 

The total income extraction would be £8,840 salary and £41,430 dividends.  The income tax liability (assuming basic personal allowance and no other income) would be £2,677.50, calculated as follows:-

• No tax on the personal allowance of £12,750. (This covers the salary of £8,840 and £3,730 of the dividends.
• There is no tax to pay on £2,000 of dividends as these are covered by the dividend allowance.
• This leaves £35,700 (£41,430 – £3,730 – £2,000) of dividends taxable at 7.5% = £2,677.50.

Total net cash received (after your income tax liability) is £47,592.50.

The company will save corporation tax on the salary element only – £8,840 x 19% = £1,679.60.

YES –  Then an annual gross salary of £12,570 (Personal allowance for 2021/2022) should be paid. 

This level of salary will not create an income tax charge, but it will create an employee’s NI charge of £360.24.  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 £50,270), then dividends of £37,700 (£50,270 – £12,570) should be paid, providing the company has sufficient reserves. 

The total income extraction would be £12,570 salary and £37,700 dividends.  The income tax and national insurance liability (assuming basic personal allowance and no other income) would be £3,038 calculated as follows:-

• No tax on the personal allowance of £12,750. (This covers the total salary.)
• There is no tax to pay on £2,000 of dividends as these are covered by the dividend allowance.
• This leaves £35,700 (£37,700 – £2,000) of dividends taxable at 7.5% = £2,677.50.
• Employee’s national insurance payable on the salary of £360. Calculated at 12% of the salary above the Primary NI Threshold (£12,750 – £9,568 x 12%)

Total net cash received (after your income tax and national insurance liability) is £47,232.50.

The company will save corporation tax on the salary element only – £12,570 x 19% = £2,388.30.

The additional salary would save Corporation Tax of £709 (19% on the £3,730 extra salary), and cost employees NIC of £360, an overall saving £349.

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