Many of our SME clients want to take some or all of the profits from their business and use them personally. There are ways to reduce the amount of tax you pay on those profits, so that your business is operating as efficiently as possible.
Here are five options to consider in how to take the profit from your company.
1: Taking a small salary
Paying a small salary can be tax-efficient if the recipient is not using their personal allowance elsewhere. Paying a salary at least equal to the Lower Earnings Limit for National Insurance purposes (£533 per month for 2023/24) will make sure the year counts towards state pension qualification.
The ideal salary will depend on whether your company is eligible for the National Insurance Employment Allowance, which shelters you from National Insurance costs on salary.
In a case where the personal allowance is available in full, and Employment Allowance is not available – which is common where a sole employee is also the director – it makes sense to pay a salary equal to the Primary Threshold. In 2023/24 this is £11,908.
If the Employment Allowance is available, an optimal salary equals the personal allowance, set at £12,570 for 2023/24.
2: Using dividends
Dividends are paid out of post-tax profits, which have already been subject to corporation tax.
All taxpayers benefit from a dividend allowance, set at £1,000 for 2023/24, so paying a dividend up to this amount is free from further tax.
Once you’ve taken an optimal salary and used your dividend allowance, if you want to take further profits it’s usually best to take dividends rather than additional salary. Dividend tax rates are lower and there is no National Insurance to pay on these.
Remember, dividends must be paid in proportion to shareholdings, and they can only be paid if you have sufficient profit to pay them. If you take dividends over the level of your profit, the difference is seen as a Directors Loan.
3: Making pension contributions
Your company can also make pension contributions on behalf of the director. The pension contributions can usually be deducted in full from pre-tax profits. As long as the contributions are within the available annual allowance and below the level of the lifetime allowance, there will be no tax charges on the recipient.
4. Paying rent
Many small businesses are based at home, and your company can pay rent for a room from the director. This is tax efficient, as the company benefits from deducting the rent from profits for corporation tax purposes.
Although the rental income to the director is taxable, they may be able to benefit from the property income allowance to receive £1,000 of rent tax-free. Another advantage of paying rent is that there is no National Insurance to pay.
5: Applying benefits-in-kind
Giving directors and family employees benefits-in-kind can be very tax efficient. A mobile phone, workplace parking or health insurance are tax-free to the employee and the company can deduct the cost from its taxable profit. Most benefits in kind are free of National Insurance.
Some benefits-in-kind can still be tax efficient even if a tax charge applies. It may be beneficial for the employee to have an electric company car, for example, rather than be given more salary to pay for the car.
The most beneficial approach in reducing your tax will depend on your specific circumstances. It’s a good idea to talk to an accountant for advice on how to manage your company’s finances in the most efficient way.
As Lune Valley accountants we help limited companies and sole traders with tax advice, company accounting and payroll services. Get in touch