“Hi, I’m Adam, Prince of Eternia and Defender of The Secrets of Castle Greyskull….Fabulous Secret Powers were revealed to me the day I held aloft my magic sword and said “By the Power of Greyskull, I have the POWER!!!!!!!””
Prince Adam and He-man were the same person, BUT also totally separate people. This is kind of what it’s like to be a Sole Trader who is now the Director of a Limited Company.
When you were a Sole Trader, you’d make your money, you’d spend your money (and claim tax allowance on what is deductible) and the rest… well that’s yours…..
There are loads of reasons why a Sole Trader would want to become Limited, but there is a time, a place and a blog post for everything 😉
Now that you are a Director, you still have THE POWER!!!!! But maybe you’re more Adam than He-man now (or maybe Man at Arms, he’s still double hard)
One reason for Incorporating your business as Limited is…..Tax Efficiency….But what in the heck does that mean to anyone?
I’ll try to make it simple for you. As your business is now Limited, the assets of the business (i.e. cash in the bank) belong to the business. Therefore you can’t just pay yourself out of the bank/till etc without jumping through some hoops (or getting your Accountant to do this for you).
So how do I get paid? I hear you yelling at your screen!
There are two main reasons why as a director of a limited company you should pay yourself a salary.
Firstly, it’s counted as an allowable business expense, which means it lowers the amount of Corporation Tax.
The second is that if the salary is above the Lower Earnings Limit (which is £6,240 in 2021/2022 tax year), you will accrue qualifying years towards your state pension.
Although I think Pensions might be a guest blog at some point……Let’s face it, State Pension is unlikely to cover your living costs once retired!
Once you have decided to pay yourself a salary, you need to decide at what level, be that lower or higher salary.
What are the advantages and disadvantages of both?
Low Salary:
The aim is to set your salary at a level that is above the Lower Earnings limit in order to obtain the benefits of qualifying for a state pension, but below the level that you need to pay either employee or employer’s NI.
The threshold before Income Tax is payable for the 2021/22 tax year is £12,750. There are also National Insurance thresholds that you should be aware of, which are currently lower than the personal allowance, and are important when setting your salary.
Be careful if you have converted from “employed” to Limited as you will be likely to hit the NI threshold immediately, and the tax threshold shortly after.
The Disadvantages:
If your salary is at a low level, or if you do not take a salary at all, there are disadvantages such as:
· Reduced maternity benefits, technically to qualify for maternity benefits, you need to be employed, and thus compliant with National Minimal wage regulations. Which is currently approximately £145 per week profit.
· You could miss out on part of your annual tax-free personal allowance if your salary is paid at the NIC threshold, and you have no other sources of income.
· Reduced cover under permanent health, Critical illness, personal accident, or similar policies where pay-outs are calculated based on your earnings.
· When applying for a loan, or mortgage, you may need to meet certain criteria which are unsympathetic to a low salary. However, this is best discussed with a mortgage broker (I know some fab ones if you want a referral)
Tax implications of taking a salary.
As with regular employees, all salaries will be subject to tax via Pay-as-you-earn (PAYE). With three separate PAYE ‘taxes’, the benefit of reducing your corporation tax liability by taking a higher salary can soon be outweighed by the additional tax paid.
Income tax
Income tax is cumulative on all employment earnings and other sources of income in a tax year. For example, if you have already earned £10,000 from any employment in a given tax year, your tax-free personal allowance would be reduced by this amount.
For instance if you’ve gone from working for a company to working for your own Limited company, you need to factor in the earnings already made in the tax year before deciding what your self employed salary will be.
Dividends
Fingers crossed, you have made a profit. If so, you have two options.
Reinvest
Keep it in the business. For instance if you were planning on making a big purchase in the next year that would potentially lead to your business being loss making next year.
Pay a Dividend
Pay shareholders by issuing a dividend. “Shareholder” means “Owners” and you can pay yourself a dividend.
This could be a tax efficient way to take money out of your own company, due to the lower personal tax paid on dividend, the rates for this year are 7.5% / 32.5% / 38.1%.
Also with dividends you receive an allowance of £2000 per year at 0% tax rate.
Through combining dividends payments with a salary, you can make sure that you are at optimum tax efficiency.
For instance, you’d pay approximately £8000 salary and £2000 dividends and have no tax or NI to pay.
Employee National Insurance Contributions
Employee National Insurance Contributions (NICs) are not cumulative. This means each new employment has a separate earnings threshold before NICs are due.
However: For employees who are Higher Rate taxpayers, there is a maximum limit on the amount of NICs to be paid. So if your last job was well paid, you need to review this with your Accountant before deciding on your self employed salary.
Directors have an annual threshold, which is 52 times the weekly threshold amount. When salary starts to go over this, they pay NICs.
In Summary
Congratulations on your Limited Company. Be that a totally new venture (exciting times ahead) or your business is going from strength to strength (again, super exciting).
You CANNOT take money out of limited company without someone running a payroll for you or it going on your Director’s Loan Account (this is only useful if you have large set up costs to pay back).
You can manage your pay to reduce your tax liability.
You can process life/health insurance through your limited company and even with the P11D requirement you will be saving some pennies.
If you want to discuss a personalised illustration of the above, give me a call and we’ll go through it step by step.
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