If you are the director of a limited company and you are trying to figure out the best way to be paid from your company then the first thing you should do is check whether you are affected by IR35 rules. IR35 is a tricky bit of legislation that looks at whether you are more like an employee than a freelance contractor, and is a bit of a hot topic. We will be talking about that more over the next few months as the rules are shifting from April onwards.
Assuming you can ignore IR35 then read on! It is usually more tax efficient to pay yourself a small salary, and then declare occasional dividends, than to pay yourself a large monthly salary. There are a few different things you need to think about when working out what the best salary level is, and it will differ depending on your circumstances. It is surprising how much of a difference it can make to your post tax income – we recently saved a client more than £10,000 a year just by reviewing their income split.
What do you need to think about?
- Do you have another source of income? If you already receive a salary from another employer then it may be better to just declare dividends from the company, depending on whether you have used up all of your basic rate band;
- If you pay yourself too high a salary then you will end up having to make both employer and employee National Insurance contributions, and those can really add up;
- Does the company has sufficient profits after deducting a rough amount for corporation tax in order to declare a dividend? You should always do a brief management review of the company’s financial position to double check that the dividend you want to declare is legal – i.e. you are leaving enough in the business to cover the company’s liabilities including tax and VAT. This isn’t a requirement when paying yourself a salary;
- What level of pension contributions do you want to make? If you are making personal pension contributions then you are limited to your relevant earnings which include salary and self employed profits, but not dividends or property income. It is likely also worth looking into making employer pension contributions directly from the company;
- If the company owes you money then it may be more beneficial to charge the business interest on that loan than to take a dividend, although you will need to declare this via submitting a CT61 form.
Don’t forget that paying yourself a salary, or making employer pension contributions, or paying interest on your director’s loan account, all save the company corporation tax. Dividends are declared from profits after deducting corporation tax, and you will then pay income tax on those dividends which is usually worked out as part of filing your personal self assessment tax return.
Your taxable income
Lastly make sure you keep an eye on your total taxable income for you as an individual. Watch out for these thresholds:
- Once your taxable income goes over £50,000 you start to lose child benefit (if applicable)
- Taxable income over £100,000 means that you will lose some or all of your tax free personal allowance, and
- Income over £150,000 results in a reduction in your annual pension allowance.
It may be worth waiting and declaring an additional dividend in the new tax year to avoid going over one of those thresholds.
There is a surprising amount to think about when looking into the best way to pay yourself out of the business. If you want advise tailored to your situation then get in touch.