A director would pay themselves slightly less than the tax-free personal allowance and take the rest in dividends. Big tax savings were available for higher-rate taxpayers.
Paying yourself a salary has never been the most tax-efficient way to extract profits, while the Treasury has been chipping away at dividends since 2017.
It’s still possible for higher-rate and top-rate taxpayers to make tax-efficient extractions from a company in 2019/20. Another option is, however, proving popular.
We assess the benefits and implications of the three most popular ways to extract profits from your company.
Tax on salary
Of course, directors can put themselves on payroll and be liable for income tax and national insurance contributions (NICs).
If your company is on course to make a profit in 2019/20, you can pay yourself a salary of up to £12,500 without paying income tax.
With five income tax bands in play, and rates ranging from 19% to 46%, you could take a wage of £12,501 and pay 19p tax in every £1 over the personal allowance.
The 19% tax rate applies up to £14,550, with an extra 1% tax (20% in total) added on earnings above that to £24,945. Another 1% above that up to £43,430 results in 21% tax.
Earnings above £8,632 would also attract employee and employer NICs, but they would go towards your state pension.
You may also be liable for workplace pension contributions being deducted from your salary at a minimum of 5%.
Tax on dividends
The dividends allowance increases your income tax-free threshold to £14,500 in 2019/20 – if you receive dividends worth up to £2,000.
Any amount above £14,500 up to £43,430 is taxed at 7.5% – and there is a significant tax jump on dividends worth more than this.
If your dividend payment exceeds £43,430 up to £150,000, you pay 32.5%. Any dividend worth more than £150,000 is taxed at 38.1%.
Extracting profits through dividends at 32.5% or 38.1% is more tax-efficient than paying income tax at 41% or 46%.
So, for example, paying yourself £14,500 in salary and £28,230 in dividends could reduce your income tax bill by 13.5% in 2019/20.
This is because the combination of salary and dividends equates to £43,430, and the tax on that is 7.5% instead of 21%.
Tax on pension contributions
With the dividends allowance reducing from £5,000 in 2016/17 to £2,000 in 2019/20, using pension contributions to extract profits has grown in popularity.
You can put up to £40,000 of your company’s profit towards your pension in 2019/20 without it being liable for tax.
Taking a mixture of salary, dividends and pension contributions can be a tax-efficient method in 2019/20.
For example, Gary is a higher-rate taxpayer and the sole director and shareholder in his company, which made profits of £46,340 in 2018/19.
He would have to pay a small amount in NICs on earnings above £8,464, but would not be liable for income tax if he received £12,500 in salary and £2,000 in dividends.
He could then put around £30,000 of the remaining profits into his pension, while the company receives corporation tax relief (19% in 2019/20) on the contributions.
Gary would only become liable to income tax at his marginal rate when he starts drawing it – but only if the amount exceeds the personal allowance.
Get in touch
Extracting profits from your limited company can be tricky business on your own, but it’s a large part of our personal tax service at Thomas Barrie.
Contact one of our advisers on 0141 221 257 or at firstname.lastname@example.org to see what tax-efficient advice we can offer you.