Registering your business as a limited company can reduce your tax liability and save you money. But getting paid through a limited company is slightly more complicated than being a sole trader.
Here's a look at the ins and outs of taxation for limited companies.
What's the tax liability for a limited company?
Unlike sole traders, limited companies don't pay income tax and National Insurance. Instead, they pay corporation tax on their profits (income less allowable expenses). The current rate is 19 percent.
How do limited companies pay corporation tax?
Corporation tax doesn't include a tax-free allowance. Nor do different rates apply depending on how much you earn. It's a straight up 19 percent deduction.
Let's say your limited company earns £100,000 in 2017/18. Your expenses total £30,000, which means you've made a profit of £70,000.
Your corporation tax liability would be 19 percent of £70,000. Or £13,300.
How do I get paid through a limited liability company?
The law considers a limited liability company to be a separate person. Any money you earn from your business belongs to the company, and you can't withdraw it from the company bank account whenever you please. To get paid, you'll need to take a salary or declare a dividend.
How do I take a salary through a limited liability company?
To take a salary through your limited liability company:
- Register with HMRC as an employer.
- Set up PAYE (pay as you earn). To do this, you'll need to download special software: either HMRC's Basic PAYE Tools or another HMRC-approved option.
- Transfer your salary from the company bank account to your personal bank account.
- Immediately after the transfer, submit to HMRC using the PAYE software you've downloaded.
What are the tax implications of paying myself a salary?
The company can deduct your salary from its profits as a business expense. But you may have to pay personal income tax and National Insurance. Depending on your salary, your company may also have to pay employers' National Insurance on your behalf.
You can avoid income tax and National Insurance by paying yourself just below the threshold for National Insurance. In 2018/19, this is £8,424 a year. This amount:
- Is within your tax-free personal allowance (in 2018/19, the personal allowance is £11,850).
- Is just under the National Insurance threshold, which means you don't have to pay National Insurance.
- Falls within the lower earnings limit, which is currently £5,876 per year.
- Which means you'll still get the benefits of paying National Insurance, even though you don't pay it.
- Is under the threshold for employers' National Insurance, which means your company won't have to pay National Insurance either.
Of course, £8,424 a year probably won't be enough for you to live comfortably. And that is where a dividend comes in.
What is a dividend?
A dividend is a share of the company's profits, paid to its shareholders. ‘Shareholder' is the legal term for a person who owns all or part of a company (read: you).
How do I take a dividend?
To take a dividend:
- First, look at the company's financial situation. You can only collect a dividend from your company's profits after tax. These are called retained profits.
- Create a dividend voucher. This details the company name, the amount of the dividend and the name of the person taking the dividend. It's a good idea to ask your accountant to help you with this.
- Transfer the money from the company bank account to your personal bank account
- Limit dividend payments to once or twice a year since more frequent distributions can attract HMRC's unwanted attention.
What are the tax implications of paying myself a dividend?
Because paid out of profits after tax, a dividend doesn't affect your company's tax position. On the other hand, you won't be surprised to hear that it affects your personal tax liability.
There is no change to dividend tax rates in 2019/20.
The final word
Dividend tax rates are much lower than income tax rates, so it can be tempting not to take a salary at all. Postponing your earnings isn't customarily a good idea.
For starters, not taking a salary means you'll fall outside the lower earnings limit. As a result, you won't qualify for the benefits of National Insurance, including a state pension. More importantly, not taking a salary could attract HMRC's attention, which is something that's always best avoided.
It's usually best to speak to a qualified accountant before deciding how to take money out of your limited company. A seasoned accountant who stays current with the tax laws is someone to heed.
