This has got to be one of the most common questions we get asked by new directors (and by those whose previous accountantsa hve just not bothered explaining things to!)
The simple answer is – through a mix of a small salary and dividends. But what does that actually mean? Why a small salary? What are dividends?
Simply, finding this mix means paying as little tax as possible (but staying legal!)
What will my small salary be?
The majority of the time, if you have no other employment or income streams, then it makes sense to take the tax-free amount of £12,570 per year as your salary – and this would be the same for each director, if there are multiple.
This takes you to the NI threshold, which means you’ll get your tick for the year on your NI record (for your state pension), but you’ll pay just a small amount of employer’s NI. We won’t go into the detail with all the boring maths here, but be assured that even paying an amount of NI to HMRC is more effective than taking a smaller, or no salary!
We run payroll monthly, file a return with HMRC and advise the amount to pay yourself (any staff) and to HMRC.
We file payroll returns through Xero Payroll and your payslips are then available on the Xero Me app.
Your salary is a tax deductible expense. This means that you will reduce your company’s profit & therefore its corporation tax liability, whilst getting tax-free money for yourself.
Win-win.
Note – this is generalised advice, and the best course may be different based on varying factors. This is why we have an in depth chat with you as you come on board, and regular catch ups, to ensure that what was once most effective still is, and to make any changes if necessary!
I need more than £12k a year though please…!
Have no fear! By no means are we saying that this is all you should take!
As long as there is more money sitting as profit in the business, you can take it as ‘dividends’.
Dividends are taxed as part of your self-assessment tax return, at the following rates;.
8.75% up to a total of £50k income
32.5% for anything over £50k total income
How do I actually make the payment?
There is no right or wrong answer to this one, everyone is different. After years of employment my preference is making a payment to myself at the end of each month which is a mix of salary and dividend. It’s a regular amount then and makes it easy to budget, both for the business and you personally.
Some clients pay themselves the monthly salary amount at the end of each month, and take top up dividends as and when they need them.
Some clients like to just take money out as and when they need it, with no regular pattern.
And some are anywhere in between! Whatever works for you is fine 🙂
The only thing we would strongly suggest(!) is that you shouldn’t use your business account (and bank card) as your personal account, and card.
Always transfer the money into your personal account then spend from there.
What is a Director’s Loan Account?
This is where we record all the payments to yourself.
Anything you pay for personally, or money you put into the business, gets recorded in here too.
We’ll also record here the Use of Home claim we include in your accounts, and any mileage expenses you put through the business too.
So, effectively we offset any payments to you against the expenses you’ve paid for and money you’ve put into the business – the difference will be your dividends!
When are dividends made ‘official’?
At the end of your company’s financial year the balance in your Director’s Loan Account becomes your official dividend amount.
Say you’ve paid yourself £10k in dividends throughout the year, but have paid out £2k of expenses. You have a balance of £8k that we declare as your official dividend for the year.
Let’s say your financial year is 1st January 2024 – 31st December 2024. Your dividends will be made official as of 31st December 2024, and will be in the 24/25 tax year and need to be included in your 24/25 tax return.
How do I prove my dividends?
Your dividends won’t show on payslips. At the end of the year, as part of preparing your accounts, we also prepare a dividend voucher which will confirm your dividend amount for that year.
How much can I take in dividends?
As mentioned before, dividends are taken out of profit after tax, so we need to make sure you don’t take more dividends than there is profit.
In the early days of your business, this can be hard to predict, and if your business fluctuates it can be quite difficult too.
Therefore, it’s crucial that we monitor throughout the year. Each quarter we prepare a report and include this balance (along with loads of other insights!), and will advise if you’re able to take more, or need to start cutting back a bit.
What if I take too much out?
As we monitor this balance throughout the year, and include in our quarterly report we will be able to spot quite quickly if you’ve taken too much out of the business.
At this point, we look at a few different options.
You could cut back on the amount you’re taking, you can repay some of the money back into the business (if you still have the cash of course!). We can also look at increasing your salary – as your salary is a business expense we can increase your salary as required to ensure you don’t take too much out as dividends. This may mean you pay a little more in tax/NI, but is more cost effective.
You can have a small balance at the end of the year which can be classed as a loan, and you have 9 months and 1 day to repay this ‘loan’ – either by increasing profits over the next 9 months to cover it, by increasing your salary as we mentioned earlier, or by repaying it, like you would a loan.
As long as the balance is either repaid in full, or there is less than £5k outstanding at the end of the year, then this will not cause any problems.
If the balance is over £5k and cannot be repaid within the 9 months and 1 day period, then you will need to pay an additional 32.5% in corporation tax on the loan amount (this is also known as S455 tax). This is why it would be cheaper to increase your salary to bring the loan down.
However, once the loan amount is cleared, HMRC will repay the S455 tax paid – but you still need to have the cash there to pay the tax in the first place. We will try all other options first to avoid paying this additional tax!
As you can see, the basics are fairly simple, but there are some pitfalls you can fall into when it comes to taking money from your business! If you would like to have a knowledgable team in your corner, guiding you through it all and keeping you tax-efficient, please fill in our Quick Questionnaire and we’ll be happy to talk!
