When setting up your business, the key aim is to drive a profit. But once your business’s revenue becomes steady and reliable, a consideration will be how to pay yourself.
Careful planning is needed to ensure that you are doing this in the most tax efficient way possible whilst also safeguarding your business’s cash reserves.
Separating yourself and the business
It’s vital to remember that your personal money is completely separate to the company money. Often owners who started as a sole trader and have then gone on to incorporate as a limited company, find it difficult to get into the mindset of isolating their business’s finances from their own.
There will be tax consequences for taking any money out of the business and this needs to be handled carefully.
Protecting the business’s reserves
When extracting cash, it is important to ensure that your business keeps enough working capital to continue running. This means that thorough forecasts will need to be undertaken to allow you to measure your cash reserves against a number of different scenarios. Then you can make an informed choice over the amount you would like to extract from the business and the timing for doing so.
Salary vs dividends
Salary and dividends incur different taxes and most of the time a combination of the two is best. However, this needs to be reviewed, particularly if there are other taxes such as Research & Development tax credits to consider. The different tax implications can be complex but at a glance:
Has the benefit of a tax-free personal allowance. It also has the advantage of running through the company payroll meaning that any tax or National Insurance contributions are taken at source monthly.
Taking a modest salary also means that you can qualify for a state pension and can reduce your Corporate Tax bill.
There are also tax savings to be had through dividends. The first £2,000 is tax-free regardless of your tax bracket and can be utilised in addition to your personal allowance.
Dividends are also taxed at a lower rate than a salary, but do not get a deduction from corporation tax.
Pension contributions can be one of the most tax-efficient ways to protect your wealth by making the most of the £40K yearly allowance (subject to income levels).
Typically clients begin to take more of an interest in pensions once cash flow is good, and they don’t need access to the cash invested.
Even if you aren’t considering a pension just yet, it is worthwhile having one set up with a small amount in. If over the pre-
ceding three years you haven’t utilised your allowances, you can use them for current contributions. This hugely increases the level of contribution when sufficient cash and profits are generated. You can also make contributions on behalf of your family members which can be useful for protecting generational wealth, subject to their role in the business.
The company can pay for items such as private health insurance on your behalf. These create a taxable benefit, for which the company pays employers NIC, and you would pay income tax. The very popular benefit currently is electric cars, which is very tax-efficient. I’m interested in cars, so can happily explain the tax benefits, and can also give my opinion on which car. I should really be on commission from Tesla and Porsche!
Extraction of profits is a complex area in tax planning, and professional advice should always be sought before you make any decisions. There are many different variables to take into account and the right approach will be as unique as your business.
If you would like to discuss the best way to pay yourself, get in touch.
T: 020 8549 5137