What is the most tax efficient method to take cash out of a business?
It’s a question that’s very often on the lips of our clients and it’s certainly a very fair question too. After all, none of us want to pay too much tax if we can avoid it. Knowing how to take cash out of a business in the most tax-efficient way possible is key for any sole trader or limited company.
The two main ways to pay yourself as a retail business owner is through a dedicated salary or dividends. Within this article, we’ll discuss the pros and cons of taking a salary and withdrawing a dividend from your business bank accounts, to try and help you make the right decision for you.
Taking a salary
If you are a sole trader, the only option you will have is to pay yourself a salary directly from your business. This is taken in the form of drawings and no payroll set up is necessary. The first £12,500 will be tax-free as your Personal Allowance, with any remaining profits up to £50,000 taxed at 20% income tax. Higher rate income tax of 40% is applicable to profits of £50,001-£150,000.
If you are a director of a limited company, you can pay yourself a salary (through a payroll) which will be a tax-deductible business expense which in turn reduces your company’s corporation tax liability.
The National Insurance threshold for paying contributions is £166 per week/£719 per month/£8632 per year.
Dividends for limited company owners
Any dividend income beyond the initial £2,000 tax-free allowance will be taxed at a basic rate of 7.5% up to £50,000, and at 32.5% between £50,001-£150,000, Over £150,000 at 38.1%.
These changes mean that incorporation as a limited company may not be as attractive to small and medium-sized enterprises (SMEs) as it once was, however there are many other benefits of operating your business through a limited company and each case should be looked at separately to assess the tax implications.
Don’t forget directors’ loans
A directors’ loan enables a company director to loan themselves money from their company books. These loans must be recorded in a director’s loan account, featuring a running balance of all funds sent to or removed from a company by a director. Any balance owed to the company by the director at the financial year end must be repaid within 9 months of the year end date to avoid further tax being imposed.
On the flip side, if a director lends funds to their company, they are within their rights to charge the company interest on their loan figure. This is recorded as a business expense for the company and a form of personal income for the director, which must be accounted for in their self-assessment tax return. This isn’t suitable for everyone though so your accountant can advise you on the most tax efficient treatment for your own specific circumstances.
Don’t forget, if you own a retail business and you’re confused by payroll, at Virgate Accounts we’re here to provide you with stress and hassle-free expertise on your business’ tax situation. Simply call us today on 01452 226111 or drop us a line at firstname.lastname@example.org and let us take control of your business finances; allowing you to focus on doing what you do best.