There are a number of benefits, and yes some costs too, arising from incorporating your business. Arguably the great advantage of owning a limited company is the ability to decide how to pay yourself in order to manage the amount of income tax that you are liable for. Whilst each individual situation needs to be considered in its entirety (hence this blog should not be considered to be professional tax planning advice) the following gives a broad illustration of how you can achieve this with relative ease and, importantly, entirely legally. I have used the rates and allowances for the forthcoming 2019/20 tax year in the illustration below and assumed a company with a single director/shareholder.
This is a perfectly legal tax planning process
It is important to pay yourself, through PAYE, a sufficient amount to protect your entitlement to the state pension.
Salaries through PAYE are currently taxed at
Basic rate (up to £50,000) – 20%
Higher rate – 40%
Additional Rate (over £150,000) – 45%
In addition salaries through PAYE are liable to National Insurance at
12% for salaries over £8,632 and then at
2% for salaries over £50,000
Dividends are taxed at different and lower rates
basic rate band (up to £50,000) – 7.5%
higher rate band – 32.5%
additional rate band (over £150,000) – 38.1%
National insurance is not paid on dividends
In addition to a personal allowance of £12,500 there is a £2,000 dividend allowance
Strategy for 2019/20
Our suggested strategy to achieve an income of £50,000 is therefore:
Pay a salary of £8,632 pa (the National Insurance Primary threshold level which protects state pension entitlement)
Draw dividends* of £41,368
You will then pay income tax of £2,663. The company will also save corporation tax of £1,640 through paying the salary of £8,632 and there is no national insurance for the individual or company to pay as earnings do not exceed the primary threshold.
This contrasts with the situation of an employee with a taxable income of £50,000 under PAYE who would pay national insurance and income tax totalling £12,464 – an effective income tax saving of £9,801. If we assume that the total profits of the company is paid out in dividends (an unlikely scenario) then the company would incur corporation tax (at 19%) of £7,860 meaning an overall tax reduction of £1,941 compared to PAYE.
*It is very important to note that dividends can only be paid out of distributable profits. This strategy cannot be implemented if there are insufficient profits.
If we can assist you in planning your remuneration strategy in order to minimise taxation please do get in touch. Thank you for reading