The Most Tax Efficient Way To Pay Yourself
When you are running your own business, there are many things that you need to keep in mind and many different factors to focus on. One of the key ones is how you can extract profits from the business in the most tax-efficient way. So, in this article, we will talk about the most tax efficient way to pay yourself.
Paying your employees is a relatively straightforward process because you only need to set up a fixed salary each month into their bank accounts, which is then recorded as a company overhead. However, when paying yourself as an owner or director, things get a little more complex.
Tax-Efficient Profit Extraction
When it comes to extracting profits from your business as pay for yourself, there are a number of methods to consider, which will also depend on how your business is set up and your role within that business.
However, it is also important to remember that the methods of extraction chosen will also affect how HMRC will tax you. It is therefore important to understand the different options available to you and how each option will affect your tax liability.
It can be complicated when running a company because there is so much financial information you might not know about, and this is crucial to get right. By listing each main option below, it should help to make the process easier to understand, so you can make a more informed decision.
Sole Trader – Drawings
If you are operating as a sole trader, the business itself is not a separate entity – in short, you are the business. Therefore, any profits the business makes is rightfully yours.
As a sole trader, you will be taxed on any profits the business makes, as this is the money you have personally earnt. You will be expected to pay Class 2 National Insurance contributions (NIC) as well as Income Tax on all profits generated.
You can withdraw cash from the business without any tax effect in the form of drawings. It is also worth noting that if you have a business bank account that is separate from a personal bank account, you can claim tax relief on interest and charges.
Tax relief is given to sole traders for expenses incurred wholly and exclusively for the business.
Limited Company – Director Salaries
When it comes to a limited company, this is a separate legal entity from yourself and therefore the way you extract money from the business will be different.
A limited company must pay corporation tax on all taxable profits. Any directors of the company are then taxed on their individual earnings via a Pay As You Earn (PAYE) salary and are required to complete a personal tax return.
This doesn’t have to be a huge salary – in fact, it shouldn’t be. The best way to do it would be to take a small salary (at least £8,000) is recommended, and then take the rest in dividends. This keeps your salary under the tax threshold, helping to reduce your end-of-year liability.
Limited Company – Shareholder Dividends
If your limited company has made a profit after all expenses (including director salaries) and corporation tax, you will have dividends to split among your shareholders.
It’s crucial to get the paperwork right if you are going to go down this route, as you will need to hold a shareholders meeting to agree on the number of dividends, as well as issue each shareholder with a dividend voucher as proof of the dividend payments.
You are also going to need to pay tax on your dividends, and how much will depend on the number of dividends you will be paying.
If you are going down this route, then it would be best to speak with an accountant who can best advise you on your individual situation.
Another method of paying yourself in a tax efficient manner is through pension contributions. This is a great way of reducing your tax liability, but it’s more of a long-term investment, so you will need to make sure you are solvent if you choose this option.
The great thing about this is that it will not be taxed until it is withdrawn, so this is perhaps the most tax efficient way to pay yourself in the longer-term.
Further Advice & Information
In this post, we have outlined just a handful of the best ways to pay yourself as a company owner in the most efficient way possible.
However, it is always worth consulting with an accountant or financial advisor to make sure you understand what this involves, and what the best way of doing it is.
If you get this right, you will be able to make the most of your earnings, and do what is best for the financial future of the company at the same time.