Tax-efficient ways to pay yourself through a limited company

There are many benefits to running a limited company instead of being a sole trader and this includes tax benefits and tax efficient ways to pay yourself.

Running a limited company gives you more tax efficient ways of paying yourself and this includes a combination of salary and dividends, as dividend payments attract a lower tax rate. You can also pay yourself additional money via pension contributions that are also extremely tax efficient.

In this blog we cover a full range of ways to pay yourself to minimise tax paid including income tax, dividend tax and national insurance contributions. Read more to find out how to pay yourself in the most tax efficient way.

Should I pay myself a salary or dividends?

"The simple answer to this is to be tax efficient, it’s often good to pay both salary and dividends, if your company makes enough profit. A combination of salary and dividend payments is often the most tax efficient way to pay yourself through your limited company."

Paying yourself a salary

Salaries are the starting point for paying yourself from your limited company. To pay yourself a salary, you need to run a PAYE scheme and report to HMRC. Paying a small salary is a starting point of tax efficient remuneration planning.

Paying yourself a salary up to £12,570 (if you have no other income except dividend payments) is covered by your tax free personal allowance and will be free from income tax, but some national insurance will be due. It may be worth paying less than the tax free personal allowance to limit paying employee and employers NI (see below re: national insurance contributions).

If you pay yourself a salary of more than the personal allowance of £12,570, then you will be liable to pay income tax. Current income tax rates are:

Corporation tax and allowable expenses

The great thing about paying yourself a salary is that it’s an allowable business expense and will reduce the amount of corporation tax your company will have to pay. (Dividend payments are not an allowable business expense).

As a limited company, you pay Corporation Tax on your profits. However, there are certain allowable business expenses that will reduce the profit and your Corporation Tax bill as well.

"Salaries are an allowable expense, so paying yourself a salary will reduce your profit and save the Corporation Tax your company pays."

Consider National insurance contributions

If you want to be entitled to certain benefits, then you will want to pay national insurance contributions on your salary payments.

You need to understand that there are thresholds for both employers and employees NI and these thresholds are different.

For example, if you decided to pay yourself a salary from the business that exceeds the National Insurance threshold for employer and employee NI, you will have to pay NI as an employee and the company will have to pay employer’s NI as well.

This may not be the most tax efficient structure to pay yourself as you’ll be paying National Insurance twice.

National insurance effect on benefits and state pension

National insurance contributions can affect your ability to claim benefits and the state pension in the future, so you need to bear in mind how many national insurance credits you have built up or need to build up.

If you take a salary higher than the Lower Earnings Limit (LEL); £6,396 per year in 2022/23 it will allow you to build up qualifying years for your future State Pension.

If your salary is above the LEL but below the Primary Threshold (£9,880) then you’ll get the benefits of NI, without actually paying it. NI contributions and NI credits can affect your state pension and other benefits such as job seekers allowance in the future.

Your income (salary plus dividends) may also affect your ability to claim Child Benefit.

Your national insurance history and how many national insurance credits you’ve built up should also be considered.

Paying yourself via dividends

If your limited company makes a profit after paying corporation tax, then this can be distributed to shareholders in the company as dividend payments.

Shareholders who receive dividend payments will need to pay personal tax on these dividends in the form of dividend tax.

Dividend tax rates can be significantly lower than standard rates of income tax and they are not subject to NI and therefore it makes them a very tax efficient way to pay yourself.

Dividend tax rates

How much tax you pay on dividends above the dividend allowance depends on your Income Tax band.

Tax free dividend allowance is £2,000.

Dividend tax rates are:

• Basic rate dividend tax is 8.75% on taxable income over the personal allowance to £37,700.
• Higher rate dividend tax is 33.75% on taxable income from £37,701 to £150,000
• Additional rate dividend tax is 39.35% on taxable income over £150,000

Can I pay myself a dividend every month?

There aren’t any rules on how often dividends are paid out to shareholders. So, you can pay yourself a dividend whenever you like. However, it’s good practice to pay these monthly or quarterly. As long as you have sufficient profits to pay the dividends.

Keep your dividend and salary payments separate just to provide a clear audit trail.

Just keep in mind when paying dividends to yourself and other shareholders the dividend tax rates and thresholds above to minimise tax.

Tax efficient pension contributions

Your limited company can make pension contributions on behalf of their directors and employees.

There are limits to how much an individual can contribute to a pension. An individual’s pension annual allowance is usually £40,000 per tax year.

Unused allowances from the previous three tax years can also be used.

The pension contributions (paid by the company) are also corporation tax deductible, reducing the company’s corporation tax payable.

This makes pension contributions a very tax efficient way to pay yourself from company profits.

Expenses

There are a variety of allowable business expenses, and some company owners make use of expenses and benefits on top of their salary and dividends. The expenses and benefits that can be claimed include things like:

• Pension and retirement benefits schemes.
• Computers and office equipment.
• Training costs.
• Company cars.
• Fuel expenses (mileage allowances) and parking charges.
• Medical insurance.
• Travel expenses, meals, and entertainment costs.
• Childcare.

Directors’ loans

A company director can make use of business funds, for a limited time and without paying any tax, through a director’s loan. However, strict time limits apply. If loans are not repaid on time, Corporation Tax and Income Tax will be levied.

A director’s loan is not considered to be a payment in the same way as salary or dividends, but it is crucial that accurate records are retained, as director’s loans are subject to their own tax rules. These records are known as a ‘director’s loan account’.

It’s worth noting also that it is not possible to simply keep making the same loan over and over again as it will attract tax. If a director’s loan is repaid within the 9 month period, but is immediately taken out again, this is known as ‘bed and breakfasting’.

Summary

In this blog, we’ve covered the basic answers to the question of ’what is the most tax efficient way to pay myself?’ However, there can be many other factors to take into account before you decide how to pay yourself tax efficiently.

Consider things like, how much money you need to live, other personal income from other sources, or whether you need to make employee national insurance contributions to claim benefits or state pension in the future. All these things can affect your decision on how much and how to pay yourself from your company.

For more help and advice on how to pay yourself in a tax efficient way call us today on 03300 886 686, or e-mail us at enquiry@dnsaccountants.co.uk.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.