Updated for 2022/23
We are often asked for advice on the most tax efficient way of paying yourself from your company.
The official term is ‘profit extraction’ – how to get more money out of your business and into your pocket – legally of course!
By far the most efficient way of taking money out of your limited company is to pay a combination of minimal Directors Salary plus a dividend and tax free expenses.
Basic Directors Salary
The Directors salary should be run through your payroll system to ensure you are deducting the correct amount of PAYE and National Insurance (NICs) on the salary that you are paying yourself.
Salaries attract NICs for both employer and employee. The salary and the NICs are both allowable expenses in the Corporation Tax return.
Employees start paying NICs when earnings exceed the
Primary Threshold (PT)
Employers start paying NICs when earnings exceed the
Secondary Threshold (ST)
We recommend you pay yourself enough to ensure you are slightly over the National Insurance threshold and pay minimum National Insurance contributions to HMRC each month to protect your NI record – by that we mean that you should pay some NICs to ensure you remain eligible for certain benefits including the State Pension.
Are paid out of profits after tax or from company reserves – i.e. retained profits after tax has been deducted carried forward from earlier periods.
Whilst Corporation Tax for small companies and Income Tax are both 20%, there is no tax advantage to the company between paying a dividend or a salary.
Dividends however, are not subject to NICs which makes them more efficient than a salary.
From April 2021, the tax rate on dividends is:
|Tax band||Tax rate on dividends over £2,000|
Tax Free Expenses
What can a director pay himself by way of tax-free expenses? Examples include but are not limited to:
- Mileage (but not commuting) for any business-related travel in own car
- Use of home office, if the director works from home
- Any ‘own pocket’ expenses incurred on behalf of the business
- Pension contribution
- Childcare vouchers – eligible in certain circumstances
How much to pay?
It does depend on an individual’s personal circumstances, but generally, directors will pay themselves an annual wage equal to or slightly above the primary threshold for NICs.
- 2018/19 £162 a week, £702 a month or £8424 a year
- 2019/20 £166 a week, £719 a month or £8632 a year
- 2020/21 £183 a week, £792 a month or £9500 a year
…HMRC introduced the Employers Allowance which allows companies to claim back the first £3000 of Employers NICs. This was great news for employers as this meant that whilst the company was eligible to claim the Employers Allowance – it is more tax efficient for a director to pay himself up to the full tax-free allowance. The director will have to pay approx £360 in the tax year 2020/21 of employees NICs at a rate of 12% (£464 2019/20) but paying NIC’s at 12% is more tax effective than paying corporation tax at 20%.
- 2018/19 £228 a week, £988 a month or £11,850 a year
- 2019/20 £240 a week, £1042 a month or £12,500 a year
- 2020/21 £240 a week, £1042 a month or £12,500 a year (not a typo, the thresholds are the same)
…HMRC decided to restrict the Employers Allowance to companies that employed more than one member of staff – small companies that have one director/employee are no longer eligible to claim the Employer Allowance which means that most single director/employee companies went back to paying the director an annual wage equal to or slightly above the primary threshold for NICs.
- 2020/21 £183 a week, £792 a month or £9500 a year
Paying Bob – a simple example
Bob is the director of a limited company, he has no other income (if his tax allowance were utilised elsewhere – i.e a pension or a second job, then we would have to rework our calculations).
He is considering his options:
- No salary. He feels that the cost and inconvenience of running a payroll is not worth the tax saving
- Taking a salary to the NIC’s threshold to minimise NIC payments
- Taking a salary to maximise his full tax-free allowance, (Bob has another member of staff)
- Taking a salary to maximise his full tax-free allowance, (Bob has no staff)
|Minimise NIC’s||Maximise Tax Allowance||Maximise Tax Allowance|
|Where Bob is sole director||
Where Bob has staff and CAN claim Employers Allowance
Where Bob has no staff and CAN’T claim Employers Allowance
|Company profits subject to tax||20,000.00||20,000.00||20,000.00||20,000.00|
|Tax at 19% for 2020/21||3,800.00||1,995.00||1,425.00||1,327.67|
|Profits available for distribution (dividends)||16,200.00||8,505.00||6,075.00||5,660.07|
|Director gross pay||0||9,500.00||12,500.00||12,500.00|
|Director net salary||0||9,500.00||12,140.00||12,140.00|
Less new dividend tax
|Directors net dividend||15,135.00||8,505.00||6,075.00||5,660.07|
|Directors total income||15,135.00||18,005.00||18,215.00||17,800.07|
|Extra cash in directors pocket||
18,215.00 – 18,005.00 =
17,800.07 – 18,215.00 =
- Director doesn’t pay himself at all (it happens!) and doesn’t get the benefit of his tax-free allowance.
- Director pays himself a market wage generating a large tax and national insurance bill that must be paid to HMRC and pays large tax or NIC contributions unnecessarily.
- Director pays himself a weekly or monthly ‘salary’ but doesn’t actually run it through payroll. If you don’t operate a payroll system then these payments are really directors loan payments that will have to be offset against a dividend later.
If you’d like to take a deeper dive into this topic, take a look at our bloody brilliant masterclass & download!