Understanding how business owners can pay themselves and the tax implications of these decisions is crucial for maintaining a healthy financial status and avoiding any potential legal issues.
There are three primary ways a business owner can pay themselves:
Salary
Business owners can pay themselves a salary through the company’s payroll, like any other employee.
The salary will be subject to Income Tax and National Insurance contributions (NICs). The salary expense is a tax-deductible expense for the company.
Dividends
Dividends can be paid out to the business owner and other shareholders of a limited company if the company has made profits.
Dividends are taxed at a lower rate than income, making them a tax-efficient way to extract money from the company.
Director’s Loan
A Director’s Loan is money taken from the company that isn’t a salary, dividend, or expense repayment.
If a Director’s Loan is taken, it will need to be recorded in the company’s accounts and reported on the Corporation Tax Return (CTR).
Tax implications and compliance
Business owners need to have a good understanding of tax liabilities, not only to ensure they’re not paying more than necessary but also to avoid any legal penalties for non-compliance.
Income Tax and NICs
Salary drawn from business will be subject to Income Tax and Class 1 National Insurance. However, if a smaller salary is taken at or below the personal allowance, business owners can avoid Income Tax and pay lower NICs.
Dividend Tax
Dividends are subject to Dividend Tax, which varies based on the overall income level of the business. However, business owners take advantage of the tax-free dividend allowance. The dividend allowance for the current tax year is £1,000. The tax rates on dividends over the allowance are as follows:
Director’s Loan Tax
If the loan isn’t paid back within nine months of the company’s year-end, there may be tax implications for both the company and the director.
The company may have to pay Corporation Tax on the loan amount, and the director may have to pay Income Tax.
Compliance penalties
Failing to comply with tax obligations can lead to serious legal and financial penalties.
For example, if the reports on salary or dividends are not accurate, or if the payments made are late, HM Revenue & Customs (HMRC) may issue penalties.
Penalties can also be incurred if business owners incorrectly classify payments. This could occur when treating a salary as a dividend.
Additionally, if Director’s Loans aren’t reported correctly or not paid back in time, additional tax charges could be handed out.
Paying yourself as a business owner requires careful thought and planning.
It is essential to understand the tax implications of the choices made and comply with all HMRC regulations. Business owners should also maintain comprehensive records to avoid any pitfalls.
If you are a business owner who would like more advice on the tax implications when paying yourself, please contact us today for help from our team of professionals.
