With the company structure still very popular with small businesses, one of the key areas of focus for directors is how to extract money in the most tax-efficient manner.

The most common mistake by small company directors, is assuming that money in the company is their money.

It is not.

With the company, a separate legal entity, money held in the company bank account is the companies money, and the director(s) will be taxed when withdrawing it.

Salary v Dividends

It is generally acknowledged that a salary with dividends based on performance, is the most tax- efficient method of paying yourself.

A salary of £9,100 per annum for a sole director, with no employees, and £12,570 for two or more directors are most tax efficient.

Directors generally withdraw amounts from the company via a directors’ loan account, with this needing to be cleared within 9 months of the year-end to avoid the outstanding balance owed to the company incurring tax at a rate of 33.75%.

Dividends can be declared throughout the year, or post year-end, but must be properly documented with minutes, and vouchers, and then be included on the directors’ personal tax return for the year in which they are received.

Company Taxable Profits

With companies now incurring a marginal rate of tax on taxable profits between £50,000 and £250,000,  it can make sense for directors to receive a salary over and above the amounts listed.

The effective marginal rate of tax on these profits is 26.5%. 

If you were to have taxable profits of £75,000, paying yourself a higher salary would save the company tax at 26.5%, with the director incurring Income Tax at 20% (instead of 8.75% on dividends).

This is based on the director being taxed at Basic Rate – if total other income puts them in Higher or  Additional Rate tax, a higher salary would not make sense.

Pension Contributions

For those who have sufficient funds to cover their lifestyle, and have the cash flow in the company, pension contributions remain a hugely efficient method of extracting money.

The company receives tax relief (at 19/25/26.5%) on the cost and the director is not taxed on this amount.

Reminder

All director remuneration should be justifiable, based on work undertaken, and any remuneration package  should take into account the cash requirements of the director(s) and the cash flow of the company.

Conclusion

Understanding how to maximise tax savings on director remuneration can save significant amounts of tax for both the company and the directors.

Discussing your options before your financial year end is key, as salaries and dividends cannot be declared retrospectively.