Using your personal allowance to reduce corporation tax
In Part 1 we established that dividends are the most tax efficient way to receive an income from business activities. Sticking with the perspective of a basic rate payer:
- You must pay Corporation Tax of 20% on company profits
- You must pay Income Tax of 0% (after the dividend tax credit) on dividends taken out
All UK tax payers receive a personal allowance on which they pay 0% income tax (wherever it comes from) on the first £9,440 (all rates and thresholds are correct as of tax year 2013/14) of income received. The threshold is a bit lower for national insurance contributions at £7,748.
Paying yourself a salary reduces your company profits and therefore reduces your corporation tax liability. So if you pay yourself a salary up to the 0% national insurance threshold you are reducing your corporation tax whilst not creating any additional tax for yourself. Win win!
That is why most small business owners pay themselves about £7,680 a year as salary and the remainder in dividends. Creating an additional tax saving of £1,536 a year (20% of £7,680). There is a bit of admin involved in this, you will have to register for PAYE and meet all the HMRC requirements that PAYE involves, but if you get an accountant they will do all that for you. It’s part of our standard service for our Contractor and Small Business clients.
Move on to section 3 of our Dividend Guide to understand the dividend tax credit (the bit that means basic rate tax payers pay 0% income tax on dividends).
Caprica Online Accountants – Dividend guide
1. Advantages of paying yourself with dividends
2. Getting the right mix between salary and dividends
3. Understanding the dividend tax credit
4. The best way to time dividend payments
5. Illegal dividends and how to avoid them
6. IR35 and Dividends (for contractors only)
How Caprica Online Accountants can help
At Caprica Online Accountants we advise all our limited company clients on the most tax efficient way to structure their pay as part of our great fixed fee online accounting packages.