Extraction of profits in a tax efficient way
One of the most common questions we get from small business owners is, “How much can I take out from my business?” It’s a valid concern—after all, it’s your money, and you’re running your business to earn a salary in the most tax-efficient way.
For sole traders and partnerships, the process is relatively simple. The money in the business account belongs to the owner, and they can withdraw it at any time. However, for limited companies, the situation is more complex.
Directors and Shareholders: Salary vs. Dividends
As a director-shareholder of a limited company, your remuneration is typically split between salary and dividends. Many directors opt to pay themselves a minimum salary (usually to align with the National Insurance (NI) thresholds) and then take additional income in the form of dividends, which are taxed at a lower rate than salary.
National Insurance Considerations
Directors are classified as employees of their companies, which means they are subject to National Insurance (NI) contributions on their salary and bonuses if they exceed certain thresholds.
- Primary Threshold: The point at which NI contributions start for employees. As of the current tax year, directors must pay NI on salary and bonuses that exceed this threshold.
- Secondary Threshold: Companies must also pay employer National Insurance if the director’s salary exceeds this threshold. This currently stands at £9,100 per tax year.
To minimize costs, many directors choose to pay themselves a salary that meets the Primary Threshold, ensuring eligibility for state benefits like the State Pension, while keeping it below the Secondary Threshold to reduce National Insurance contributions for the company.
While paying up to the National Insurance (NIC) threshold can be a tax-efficient approach, it may not be suitable for everyone. To qualify for the full State Pension in retirement, you’ll need 35 qualifying years of National Insurance contributions or credits.
Although voluntary contributions are an option, it’s generally easier to stay on track with your contributions through regular PAYE payments.
Salary vs. Salary/Dividend Mix
One of the most popular strategies for directors is to combine a low salary with dividends. Dividends are taxed at a lower rate than salary, and since they are not subject to National Insurance, this structure can be more tax-efficient.
Example: Salary vs. Salary/Dividend Mix
Let’s assume a director wishes to withdraw £50,000 from their company. Here’s a simplified comparison of the tax implications for taking this amount as a salary, versus a salary/dividend mix: (The tax and national insurance rates used are for 2024/25 tax year)
Key EE: Employee; ER: Employer; NI: National insurance; Co: Company
| Tax and NI liabilities based on £50k salary per tax year | |||
| Salary | 50,000 | ||
| Tax free | 12,570 | ||
| Taxable | 37,430 | ||
| tax due @ 20% | 7,486 | A | EE pays |
| EE’s NI free | 12,570 | ||
| NI’able | 37,430 | ||
| NI due @ 8% | 2,994 | B | EE pays |
| ER’s NI free | 9,100 | ||
| NI’able | 40,900 | ||
| NI due @ 13.8% | 5,644 | C | Co. pays |
| Total tax and NI due (A + B + C) | 16,124 | D | Total payable by both Co + EE |
| Tax and NI liabilities based on £9,100 salary and £40,900 dividends | |||
| Salary | 9,100 | ||
| Tax free | 12,570 | unused allowance to be used by dividends | |
| Taxable | – | ||
| tax due @ 20% | – | A | EE pays |
| Dividends | 40,900 | ||
| tax free | 3,970 | £500 tax free + unused personal allowances | |
| taxable dividends | 36,930 | ||
| tax due @ 8.75% | 3,231 | B | EE pays |
| EE’s NI free | 12,570 | ||
| NI’able | – | ||
| NI due @ 8% | – | C | EE pays |
| ER’s NI free | 9,100 | ||
| NI’able | – | ||
| NI due @ 13.8% | – | D | Co. pays |
| Total tax and NI due (A + B + C + D) | 3,231 | E | Total payable by both Co + EE on salary |
| Corporation tax @ 19% payable | |||
| on profit after salary (50,000-9,100) | 7,771 | F | Total payable by Co on profit |
| Therefore, total liabilities (E + F) | 11,002 | Total payable by both Co + EE | |
(Note: The actual percentages depend on the current tax year’s tax brackets and thresholds, and you should consult with a tax professional for specific calculations.)
Strategic Planning
The optimal strategy for withdrawing funds from your company depends on your personal circumstances, financial goals, and the current tax rules. Here are a few key points to consider:
- Salary level: Set your salary at a level that qualifies you for state benefits (like the State Pension) and minimise National Insurance contributions.
- Dividends: Pay dividends on profits after corporation tax, ensuring they are within the tax-free dividend allowance and at the lower tax rate for dividends.
- Tax efficiency: The combination of salary and dividends generally offers the most tax-efficient approach for directors, provided it’s structured correctly.
By balancing salary and dividends, you can maximize your take-home pay while keeping your company’s tax liabilities in check.
Need Help Navigating Salary and Dividend Planning?
If you’re unsure about the best way to withdraw funds from your company or need help calculating the most tax-efficient approach, our team of experts is here to help. Contact us to discuss your specific situation and create a strategy that works for you.
