Working through a limited company offers an alternative to standard sole trading; however, there are differences to consider. For example, the way in which you are paid is often much more straightforward for sole traders. When it comes to trading through a limited company, there are a number of different ways in which you can be paid, and all of these have implications when it comes to tax. With this in mind, what is the most tax-efficient way?
IR35
Before you can make any decisions about pay, you have to ascertain whether you are affected by the IR35 legislation. IR35 is a way for HMRC to crack down on contractors who are basically employees in all but name. This can affect those who work through a limited company, but the decision is on a case by case basis and is usually decided by the client. Those who are affected will either be placed on payroll, or a payment will have to be made to HMRC to make up for the potential loss in tax. IR35 is a complex issue, and directors should ensure they don’t fall under this legislation before making decisions on how they are paid.
Salary vs Dividends
Those who are self-employed follow a reasonably simple payment structure; however, when working through a limited company, the director chooses how they are paid, with the main options being salary or dividends. When being paid a salary, all the usual tax rules apply, and your personal tax-free personal allowance will be affected. However, a dividend is a payment that can be made to the shareholders of the limited company, out of its profits. It’s worth noting that dividend payments can only be made out of the company’s profits, after corporation tax.
There are financial implications to taking a salary; for example, if you have multiple incomes, it can be very easy to hit a high tax threshold. Also, those who opt to take a higher salary could end up having to pay for both employer and employee national insurance contributions.
The alternative approach is to incorporate dividends into your payment plan, whether this means a combination of salary and dividends, or simply just dividend payments on their own. It’s worth noting that you must ensure that your dividend payments are legal before going forward with them. This means calculating whether the company has enough money left from its profits after you’ve taken the payment. This includes enough money to pay corporation tax and enough to cover liability.
Another issue to factor in is whether the company owes you money via a director’s loan. If it does, then it may be more efficient to just charge the company interest on the loan, rather than taking a dividend.
Important Figures
One of the main ways in which to utilise dividends is if your personal taxable income is close to hitting a major threshold. Just some examples to watch out for:
- Over £50,000, you will begin to lose child benefit.
- Over £100,000, you will lose some or possibly all of your tax-free personal allowances.
- Over £150,000, you will face a reduction in your personal pension allowance.
Obviously, these are quite drastic financial changes, but they can be avoided. If you are getting close to hitting one of these boundaries, it may be beneficial to wait until the new year and declare an additional dividend, therefore retaining these benefits.
As with many aspects of self-employment and particularly working through a limited company, there are lots of factors to consider. It’s easy to become overwhelmed with all of the regulations. If you would like advice on the best way to approach limited company pay, give us a call, and we can discuss what is best for you.
