Paying yourself can either seem extremely straightforward or generally difficult. In both cases you might not know the whole picture, so below is a short video summary to explain how to pay yourself from a limited company.
Keep reading if you'd like to know more...
The Difference Between Salary and Dividends
Before we can even delve into paying yourself from a limited company, we first need to establish the difference between salary and dividends.
Salary is paid to company employees in exchange for their time through PAYE (Pay As You Earn) submissions to HMRC. These are monthly payroll submissions that detail the employee's earnings and tax deductions based on a yearly or an hourly wage.
Almost anyone can be a company employee provided they are legally allowed to work and stay in the UK, and are actually working in some capacity for the company. A simple time for money exchange that's regularly paid each week or month to the worker.
Dividends on the other hand are rewarded because you own a part of the business through shares. Being a company shareholder entitles you to a portion of its distributable profits when the company decides to pay dividends.
If you're a sole shareholder in the company, you'll be entitled to all profits after tax. Good accounting software such as FreeAgent and your accountant can help you confirm this amount in your company.
When dividends are paid, it's usually on a quarterly basis. More frequent dividend payments can look like other income to HMRC such as salary. They will request the appropriate tax if this is the case (20-40% plus national insurance).
Tax on dividends is calculated once per year on your self-assessment tax return. Your accountant will be able to complete this for you. The tax year runs from 6th April and ends on 5th April. You have roughly 9 months to pay any liability by the following 31st January.
- Salary is taxed immediately each month
- Dividends are taxed yearly with a self-assessment return
- Salary payments are consistent weekly or monthly amounts
- Dividends are paid each quarter, or generally less often and depend on company profit
Now that we've determined how salary and dividends are different, let's look at the actual process of paying yourself from a limited company.
Setup your PAYE registration & start running payroll
Before you can pay any salary from your company, you need to setup a PAYE registration. Your accountant can do this for you but sometimes at an additional cost. Our all-inclusive service includes registration and running payroll each month in compliance with HMRC.
Determining how much salary to pay is another matter. This varies between single director companies, husband and wife companies, and companies with multiple employees. Regardless, salary is an essential part of the company. It's important to incorporate it from the beginning.
Employees should be paid what they're worth based on market rates. Normally you can decide an annual salary, such as £35,000. Then simply enter the monthly or yearly amount into your payroll software. Make sure that your company is receiving enough income to cover your employees' salary.
As a company director/shareholder which most contractors are, it's recommended to pay yourself a lower salary as anything above your personal allowance will be taxed at 20% along with National Insurance Contributions. This cancels out any Corporation Tax savings from your limited company. We can suggest the best level of salary as part of our service.
There is also the option to pay yourself only in salary, however this is much less tax efficient. It could also lead to smaller companies having cashflow issues.
If you keep all of these things in mind, you should be able to come up with a reasonable figure for your salary.
Work out your company's profit after tax
What does profit after tax mean exactly? It's when you take all of the company's income, deduct expenses to come up with the profit figure, and finally deduct Corporation Tax.
This final figure is actually what your company can use to pay dividends. A simple calculation would be as follows:
£30,000 Turnover (from invoicing)
-£20,000 Expenses (includes Salary)
-£1,900 Corporation Tax (19% in this example)
£8,100 Profit (Distributable Reserves)
A good accounting software can do this calculation for you if you simply update what happened in the company. For example if you use FreeAgent, you would add invoices, expenses and bank transactions up to date for the software to tell you how much is available to take as dividends.
It's important to only take dividends when the company has profit to do so. Otherwise these are called 'illegal dividends' or 'director's loans' and have multiple tax implications.
Overall it's best to avoid such a scenario as the company won't be able to pay its Corporation Tax which could result in a forced closure by HMRC and Companies House.
Treat your limited company as a separate entity
Your company's income is just that: your company's income. Having a Ltd company doesn't mean you can treat is as your own personal piggy bank. This is where a lot of contractors and freelancers run into trouble with HMRC.
The limited company will have its own business bank account for a reason. The company will have its own tax to pay as well as expenses. You shouldn't pay for personal items with this account. If you do, then it'll create a director's loan or benefit in kind. This works out worse overall from a tax efficiency standpoint and generally complicates things with additional form submissions.
So when you're paying for something with the business card or transferring money to yourself, remember that it will have an impact on your company or personal tax. Always consult a professional (like us!) if you're not sure.
Reward yourself with dividends
A limited company provides many benefits, including none other than dividend payments. Depending on how many shares you own in the company, or if you're the only shareholder, you can receive a portion of the profits.
Once you've worked out the company's current profit after tax figure, you can choose to take this as a reward for your initial investment or share(s). So if we use the example above, the current available figure is £8,100 and you would like to take £5,000 this quarter.
The remaining £3,100 will be left in the company as extra reserves. This money can be put back into the company to help it grow, invested into a private pension scheme, or left in the company when there's no contract work.
In turn, you'll only be taxed on dividends that have actually been withdrawn. Even though they don't count as a company expense like salary, their tax is much lower and there is no national insurance to pay.
Repay yourself for expenses
Expense reimbursements are not exactly a form of income, however they are a major benefit to running a limited company.
Why? Well for starters, you won't ever be out-of-pocket compared to Umbrella arrangements as long as your company is operating outside of IR35. Check out 5 IR35 Questions to Ask Yourself. You also get to receive Corporation Tax relief on valid expenses, reducing your tax bill at the end of the trading year.
Here are some common business expenses that you can claim for with a limited company:
- Use of Home Allowance (£4 per week without receipts)
- Business Phone
- Mileage Allowance (£0.45 per mile up to 10,000 miles)
- Travel & Subsistence Costs
- Equipment (Computers, Laptops, Machinery etc)
When you claim allowances like Use of Home and Mileage, your company physically pays you back for these costs which means more money in your pocket. Keep reading >> Limited Company vs Umbrella – Don’t lose £1,000s
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