A question that comes up a lot for clients starting their own businesses is an important one and is “how do I pay myself?”. Usually this will fall into two categories, salary and dividends, which we will cover in more detail below.
Each year you need to earn a certain amount of income from an employment in order to keep your national insurance record intact i.e. have enough qualifying years for your state pension. As with most taxes, there is a nil rate band where you do not have to pay anything and national insurance is no different.
It therefore makes sense to utilise this nil rate band and pay the minimum amount of salary that is required to keep your national insurance record intact. Paying more than this attracts unnecessary national insurance contributions and is therefore not usually tax efficient.
Any salary payments made must be reported to HMRC under Real Time Information (RTI). This is something that we do when we generate a monthly payslip for you although please note that we can’t make the salary payment for you! You simply need to transfer the money, as per your payslip, from your business account to your personal account.
As the monthly salary amount is small (around £760) and not enough for most people to live on, any other money drawn from the company is taken as a dividend.
Dividends are simply a reward for owning shares in your business. You may well hold shares in other larger, well known companies and when you receive a dividend from these, they are no different.
The first advantage to dividends is that they do not attract any national insurance. Secondly, everyone is entitled to tax free dividend income of £2,000 each year. Any dividends drawn over this amount (assuming your personal allowance is fully utilised) will be taxable at 8.75% in your basic rate tax band. Any that take you over your basic rate tax band are taxable at 33.75%, then at 39.35% in the additional rate tax band. This is a savings compared to a rate of 20%, 40% and 45% which you would pay as a sole trader or a PAYE employee.
The most important thing to understand regarding dividends is that they can only be paid if the company has sufficient post tax profits (called retained earnings). For example, if after paying all its costs, the company has £10,000 in the bank account, we recommend that you only draw up to 80% of this amount as a dividend (you don’t have to take that much). By doing this you are ensuring that you are leaving enough money in the business to cover the corporation tax liability and not spending the company’s tax money! Please note that this method aims to cover the company’s corporation tax liability and you will need to ensure that you are saving personally for your personal tax liability i.e., the tax due on your dividends.
Dividend payments should be an easy and straight forward way to draw money from the business but, things to watch out for are:
- As we mentioned above, dividends can only be paid if the company has enough post tax profit to cover these. If dividends are paid and there are not sufficient profits to cover these, the money has to be treated as a loan to you rather than as dividends and will need to be repaid to the company
- Dividends can only be paid to the shareholder(s). If, for example, you want to pay for some personal expenditure, perhaps some building work or your personal tax bill, you should pay yourself the dividend first and then make the payment to the third party from your personal account. A payment made from the business to a third party in a private capacity is not a dividend and, as with the example above, this would need to be treated as a loan to you
- You may have another shareholder(s) in the business and, if so, it’s important to remember that any dividends paid, must be paid in the correct shareholding ratio. For example, if there are two shareholders, one with 40% and another with 60%, and a dividend of £4,000 is declared then this will be paid £1,600 and £2,400 to the shareholders respectively
For most small, owner managed businesses the above structure works well as it:
- Ensures that your national insurance record remains intact whilst utilising the nil rate band of national insurance
- Gives greater flexibility/control for personal tax planning enabling the payment of dividends to be made when it’s most suitable to you
- Subject to the cautions above, dividends are easy to administer and keep track of for planning purposes
Please do note that everyone’s personal circumstances are different and it’s important to take advice from an accountant when setting up your company to ensure your tax affairs are looked after in a tax efficient manner. Please do get in touch with us on 01926 851516 if you’d like further advice and assistance with salary and dividend payments.