4 Tips for tax efficient profit extraction
As a business owner, it’s important to consider how you will take money out of your company in order to maximise the cash you receive. You’ll usually have some flexibility when deciding how to pay yourself, so make sure you understand what the rules are, and the options available to you in order to minimise your tax charges. At Stewart & Co we recommend considering this at least annually, to take account of changing tax bands and allowances but you may wish to consider this more often where there are changes to your business or personal circumstances. So, what 4 things should you be considering for tax-efficient profit extraction?
Does the company have positive reserves?
Company’s which make a profit year on year will generally have distributable reserves (excess profits). These reserves are important as a company must have distributable reserves in order to pay a dividend. As the owner, this means you have more options when deciding how to pay yourself. For companies which have a history of losses, or have only recently turned a profit, extracting money can be trickier and will generally have to be in the form of a salary so we’d recommend getting in touch if this is you.
Most company owners typically take some of their earnings in the form of a salary. A key consideration is the level of salary which you should take. The common approach is to take a smaller salary, with the balance taken in the form of dividends. Whilst everyone’s circumstances are different, this generally helps to reduce the tax suffered as salary is taxed as income at the following rates:
- 0% (up to £12,500)
- 20% (from £12,501 to £50,000)
- 40% (from £50,001 to £150,000)
- 45% (£150,001 +)
By comparison, dividend tax rates are lower (see below), helping to reduce overall taxes.
Salary is also subject to National Insurance which starts on income over £8,632 and so a salary of £12,500 would not be subject to PAYE but would suffer tax in the form of NIC’s. Some suggest setting a salary of £8,632 for this reason, but we’ve crunched the numbers and think a slightly different approach maximises the cash you receive. We’d be happy to talk you through this so get in touch here if you’d like to find out more. Remember, National Insurance contributions also count towards your qualifying years for the State Pension.
Where owners take a small salary, the balance can be taken in the form of a dividend. The first £2,000 of dividends are tax free with amounts above this taxed at the following rates:
- 0% (up to £12,500 where personal allowance still available)
- 7.5% (from £12,501 to £50,000)
- 32.5% (from £50,001 to £150,000)
- 38.1% (£150,001+)
These lower rates of dividend tax help to maximise the cash you receive and its worth noting dividends aren’t subject to National Insurance either.
A company can make a contribution direct to the owner’s personal pension scheme, and for most people this means you can put up to £40,000 per year in to a pension plan tax free. Not only this, but the company benefits from a corporation tax deduction on the contribution – a Win-Win. For owners who don’t need any more cash now, this helps to maximise the profit you extract without suffering any immediate tax consequences.
If you’ve held a pension plan previously but not used all your £40,000 allowance from earlier years, there is scope to go back and use unused allowances for up to 3 previous years, so if this is you and you’d like to make additional contributions we’d recommend getting in touch.
A word of warning
“Don’t let the tax tail wag the dog”
Or in other words, just because a particular approach is tax efficient doesn’t mean it is best for you. After all, tax on its own, should not dictate your approach and is just one thing to consider. Instead, make sure you understand your goals and what it is you are looking to achieve, then consider the tax consequences.