If you’re running your own company, you decide how much you pay yourself.
But although it is your business, it is not quite your money. The wealth you work so hard to build up belongs to the business, not you. If you take that money in the wrong way, you could find yourself liable for some costly tax penalties.
At Continuum we are looking at ways to extract profit from your business, without giving a large share of it straight to the taxman.
Reducing your tax liability is legitimate.
You must not break the rules on tax, and those rules can be complicated.
What’s more, the government has tightened several of them up in recent years, in a bid to maximise treasury revenues.
Some of the techniques that helped reduce tax in the past will not work now – you need to know what the changes are to avoid costly surprises.
But there is still no rule that says you must take profits out in a way that gives the most tax to the government. You are perfectly entitled to organise your affairs to pay the minimum amount of tax – as long as it’s within the rules – and at Continuum we know the ways to help.
There are three main routes for a business owner to extract profits from their own limited company: salary, dividends, and pension contributions.
Making the least of your salary
Most business owners with their own company will reduce their tax bill by paying themselves a small salary and take the other income they want as dividends.
This is because your salary will attract income tax.
Pay yourself less than the income tax threshold of £12,571 and there is no income tax to pay.
From £12,571 to £50,270 you will pay 20% – basic tax.
From £50,271 to £125,140 you pay tax at 40% – higher rate tax
And if you are in the position to pay yourself over £125,140 per year, the taxman will share your good fortune at 45%, with additional rate tax. But the actual tax burden can be higher because you do not get a Personal Allowance on taxable income over £125,140.
Keeping your salary small means paying less income tax but the advantages don’t stop there. It also means smaller National Insurance Contributions (NIC), which are charged as a percentage of your salary. However, the rates for NIC contributions have become more complicated – as an employee, you could be asked to pay 5.85% or 12% and depending on a variety of factors, an additional 2% on earnings above the upper earnings limit of £50,270 per year. Your business would have to pay 13.8% employers NIC on your salary – but at least that is consistent across almost every category.
The position on NIC is complicated, but you can find some clarification from the government here – or by contacting us at Continuum.
Making the most of your dividends
In previous years, paying yourself with dividends from your business, rather than a salary used to be the simple way to reduce your personal tax.
The government has made some changes to the rules. Dividends can still reduce or eliminate your income tax liability, but they are not tax free. You can only pay dividends on profits generated, after corporation tax charge, which for companies with profits under £50,000 is 19%, while those with profits over £250,000 is 25%, with a sliding marginal relief for those in between.
The amount of tax you pay on dividends then depends on your total income and tax band. You can earn some dividend income each year without paying tax, and for the tax year 2023-2024, the dividend allowance is £1,000. The rate of dividend tax you pay depends on your tax band 2. For the 2023-2024 tax year, dividend tax rates can range from 0% up to 39.35%, depending on your marginal rate of dividend tax, which in turn is linked to your income tax band.
How much tax you pay on dividends above the dividend allowance depends on your income tax band.
Basic rate income taxpayers pay 8.75% dividend tax.
Higher rate income taxpayers pay 33.75%
Additional rate income taxpayers pay 39.35%
But remember, your dividend tax allowance could already be used up by other payments you have received. If you have investments that pay dividends, your allowance could be eaten up.
Dividends still have a role to play in reducing your tax liability, but they are much less effective than they used to be.
Making more of your pension
Your pension is vital for the future, but it could also help you pay less tax now.
In fact, it could be the one area where the government’s recent round of tax changes could work in your favour.
You or your company can (from the current tax year) now put up to £60,000 per year in a pension plan, assuming you earn that much. The lifetime allowance charge has been removed and there are plans to remove altogether the lifetime allowance, which limited the total you could amass in your pension pot – which means that making the most of your pension could be more rewarding than ever.
Your pension is tax-efficient and has the added protection of being outside your business – and possibly out of reach of creditors if things go wrong.
But if you run a business, your pension can work even harder for you. Take your pension out of your profits, and you have less corporation tax to pay. Get the numbers right and you pay less income tax and National Insurance both as an employee and an employer.
If you are close to the threshold of a higher tax bracket, earning near £50,270 which would take you out of basic rate tax and into higher rate tax, or earning £100,000 plus, where personal allowance starts to taper off, making the most appropriate pension contribution in the most suitable way could also help you stay below the threshold.
The possibilities don’t stop there. Small Self-Administered Schemes or SSAS pensions can let you decide how to invest your pension contributions – and you can invest in your own business. The current rules are that your SSAS can lend up to 50% of the total held to your business, making it a valuable source of additional funds. There are some restrictions. The money loaned must be a real investment, rather than an interest-free loan and must be paid back by the company with a reasonable rate of interest. However, it can be at a rate substantially below that offered by a commercial lender.
So, with an SSAS, you could potentially use your pension fund to buy your business premises or major capital equipment or fund any other business initiative that can bring an identifiable return.
Using your pension in this way carries some risk – and as always with pensions, expert advice is essential.
Getting the help, you need
The latest rules about tax are more complicated than ever and any steps you take to reduce your liabilities will have to be taken very carefully. Having an expert at your side will be vital, and at Continuum, we can provide the expertise you need.
To talk to us about profit extraction, and how it can be integrated into your broader financial plans, contact us today.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment or tax strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested.
Levels and basis of reliefs from taxation are subject to change and depend upon your personal circumstances.
The Financial Conduct Authority does not regulate taxation advice.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Pension income could also be affected by interest rates at the time benefits are taken.