There are many ways to take money from your business, but which one is most effective for you?

Find out more by watching our video.

With the current tax rate, paying a dividend rather than a salary will often be a more cost-effective way of withdrawing profits from a company.

 

Tax is currently payable on any dividend income received over the £2,000 dividend allowance at the following rates:

 

  • 5% on dividend income within the basic rate band
  • 5% on dividend income within the higher rate band
  • 1% on dividend income within the additional rate band

 

But, if the company has no retained profits and is loss-making, it will not be possible to declare a dividend, and an alternative will need to be considered. Usually, this would include an increase in salary or a one-off bonus payment.

 

WHAT ARE THE TAX IMPLICATIONS?

 

Both types of payment attract income tax at the relevant rate of tax – 20%, 40% or 45% as appropriate.

 

From a National Insurance Contributions or NIC’s perspective, any potential cost savings will depend on whether the payment is made to a director or an employee.

 

For NIC purposes, Directors have an annual earnings period. This means that NICs payable is the same regardless of how frequently the payment is made – whether it’s made in regular instalments or as a single payment. Since there is no upper limit of employer/secondary NICs, the company’s position will be the same regardless of whether the payment is made by the way of salary or bonus.

 

When a bonus or salary payment is made to another family member who is not a Director, the earnings period rules mean that it may be possible to save employees’ NICs by paying a one-off bonus rather than a regular salary.

 

HOW DOES THIS WORK?

 

Here is an example that demonstrates.

 

Paul is the sole director of a company and an equal 50% shareholder with his wife Gill. They each receive a salary of to use up their personal allowance.

 

In the current year, the company makes profits of £24,000 (after paying the salaries).

 

The profits are to be shared equally between Paul and Gill.

They want to know whether it will be more cost effective to take the profits as an additional salary – each receiving an additional £1,000 per month for the next twelve months – or as a one-off bonus payment with each receiving £12,000.

 

The income tax position will be the same regardless of which method is used.

 

As Paul is a director, his NIC position will be the same regardless of which route is taken as he has an annual earnings period for NIC purposes.

 

Gill is not a director, so the normal earnings period for NIC in a month will be the interval in which her existing salary is paid.

 

Using the current NIC rates and thresholds, if Gill receives an additional salary of £1,000 a month, she will pay Class 1 NIC of £120. This is £1,000 at 12% a month on that additional salary. Her annual NIC bill on the additional salary of £12,000 will be £1,440.

 

However, if she receives a lump sum bonus of £12,000 in one month (in addition to her normal monthly salary), she will pay NIC on the bonus of £585. This is less because part of the bonus is above the NIC threshold and only attracts NIC at 2%.

 

Paying a bonus instead of a salary reduces Gill’s NIC bill by £855.

 

 

Finally, it is important to consider when deciding how to extract money from the business in the best way for you, tax should never be the only consideration. Any extraction should be in line with the wider goals and aims of the company.

 

I hope that’s useful.

 

If you’d like to know any more, please get in touch with us.