Tax Efficient Profit Extraction

 

If you are a director of a family company then you will want to make sure that you are extracting profits from your business in a way that is the most tax efficient. Whether this is by salary, dividends or pension contributions (for future use).

The reduction in the dividend allowance for 2018/19 and changes to the rates and allowances will impact on directors of personal and family companies looking to extract profits in a tax-efficient manner. As always, the optimal strategy will depend on circumstances.

It is generally beneficial to take a small salary, particularly where the recipient does not have the 35 qualifying years needed for the full single tier state pension. Where the employment allowance is not available (as is the case for a company with a single employee who is also the director, or where it is utilised elsewhere), the optimal salary for 2018/19 is one equal to the primary threshold for Class 1 National Insurance purposes, set at £8,424 for 2018/19 (equivalent to £702 per month).

If the employment allowance is available, for example in a family company with a number of employees, the optimal salary is one equal to the personal allowance of £11,850, assuming it is available and not used elsewhere. Above these limits, it will generally be more beneficial to extract further profits as dividends, making use of shareholders’ dividend allowances and basic rate bands, where possible.

 

Below we take a look at the salary at varying thresholds and the rates of taxation to determine the best extraction option.

 

£0 to £8,424	At this level your salary would have no income tax, employee or employer NI to be paid. Dividends will have corporation tax of 19% deducted but no personal tax liability. In this instance salary would be the preferred extraction.
£8,424 to £11,850	Here again there would be no income tax deducted but there will be employers and employees NI deducted at 22.67%. Again dividends would have 19% corporation tax deducted. Dividends would be the better option.
£11,850 to £13,850	Your salary at this level will be subject to income tax, employee and employer NI, a rate of 40.25%. The £2000 zero rate can be applied in this range of remuneration, as the dividends so far used the unused personal allowance. Again these would be taxed at 19% corporation tax  and no individual liability exists. Dividends again would be the better extraction.

 

Conclusion

There are a limited amount of options when extracting company profits, as each option will have their own National Insurance or Tax consequence for business owners. That said, depending on your situation there is always an option which may be better suited to you.

You should always seek advice when extracting profits from your company and if you would like to discuss profit extraction then please contact us for further information.