12 Oct Let’s talk tax efficiency
Fed up with Covid-19 updates? Then let’s take a well-earned break and talk about how we can save you money by making you more tax efficient as a Limited Company.
Limited Companies (Ltd Co.) have long been heralded a tax-efficient business structure, allowing Ltd Co. Directors to split their income between salary and dividends (a share in the business’ profits). So why is this a benefit, well these are the two most documented reasons:
- By paying yourself in this way means you may not have to pay any PAYE (income tax) or NICs at all on your salary if it falls below the current threshold.
- Dividends are taxed but are not subject to National Insurance Contributions, which represents a significant tax saving compared to the sole trader route, where NICs are payable on all income.
It should be noted that this tax relief is intended to allow for particular overheads such as holiday or sick pay, purchasing equipment necessary for the job and supporting a pension pot.
Why not stay as a Sole Trader?
There is an argument to say that a limited company can look ‘more professional’, but the key reason is that it offers some financial protection (limited liability protection) protecting shareholders and owners from being held personally responsible for their company’s debts or financial losses. Plus, there are even more tax advantages in addition to the two stated above:
- Pay less tax on profits – unlike sole traders whose tax rate increases with higher profits, a Ltd Co. pay corporation tax on their profits at a flat rate of 19%
- Hold on to extra profit – unlike sole traders you can defer your personal tax by withdrawing some of your profits later when it is more tax-efficient to do so
Ok, so I’m sold on registering as a Ltd Co., tell me again why I need to pay myself a salary?
In a nut shell, because it reduces your end-of-year corporation tax bill.
A PAYE salary counts towards your allowable business expenses which in turn reduces your profit and corporation tax bill. So, although you’ll have to pay income tax on the salary you take, as long as it stays below your personal allowance of £12,500 you won’t be liable for any additional tax.
If you want to accrue qualifying years towards your state pension, but not have to pay National Insurance contributions – the current (20/21) optimal rate is £732 per month.
Therefore, taking a salary somewhere between £6,000 and £12,500 is actually more tax efficient than not taking a salary at all.
Please remember that these scenarios may differ for your personal circumstances so you should always seek advise from an accountant (us!).
What if I want to pay myself a higher salary?
There are some benefits to paying yourself a higher salary. Firstly, Rishi will love you the more for it, because let’s be honest his honey pot is probably running a little dry right now.
But also, although it’s not more tax efficient, higher salary benefits could include:
- Higher earnings will make you look great should you need to apply for a loan or mortgage (more on this in my next blog!)
- Maternity allowance qualification, as the rules are that you (‘you’ being a Female Director) must have paid National Insurance for at least 13 of the 66 weeks before your baby’s due to qualify for maternity allowance
What if I just paid myself in dividends?
A few years too late I’m afraid, HMRC have cottoned on to this little nugget and now tax on dividends.
However, the first £2,000 of dividend income in a year is tax-free. Anything above that you will pay dividend tax on (on a scalable rate), but you won’t have to pay any more income tax or NICs because you’ve already paid corporation tax on this money.
Unfortunately, dividends do not count as a business expense, so taking them won’t reduce your corporation tax. But, income from dividends is still taxed at a lower rate than salary income, which helps to increase earnings and not your liability.
So finally, let’s put this salary vs dividend concept into practice:
- Personal Tax Allowance – £12,500
- Plus, your tax-free dividend allocation – £2,000
- We already have an income of £14,500 without any tax liability
- Let’s top up these earnings with more dividends up to £35,500 (the threshold for basic-rate tax payers is £37,500, including the £2,000 allowance)
- You could take as much as £50,000 home with a personal tax bill of just over £2,662.50
Worried you’ve not been thinking about Covid-19 for more than ten minutes? Don’t panic, I’ve got plenty of blogs on the subject to keep you going here’s one I made earlier.
If you’d like to have a chat through anything, just book in some time with me using this link here.