If you’re considering setting up your own contracting firm by trading under a Limited Company, then taking a mix of salary and dividends is the most tax-efficient way to take income from the business.
Due to the implications associated with drawing a £Nil salary, many contractors choose to pay themselves a modest salary, topped up with dividends.
For instance, you could pay yourself a basic salary up to the limit of when NI contributions become payable – the threshold for the current 2018/19 tax year is £8,424. Yet, while it’s your decision to do this, remuneration at the NI threshold is lower than the National Minimum Wage.
As of 1 April this year, the National Minimum Wage for people aged 25 and up is £7.83 per hour which, when full-time hours are considered, works out at approximately £14,250 per year. Taking a salary at this level may be a better alternative to taking one below the NI threshold, as it will demonstrate your intention to operate a genuine commercial, contracting business. There is no advantage to withdrawing a salary in excess of this figure however, except in ‘special’ circumstances.
Drawing a £Nil salary
So, you may be wondering: Can I take all my income as dividends and not pay myself a salary? The short answer is yes, you can; however, doing this has a number of implications you need to be aware of. These include:
The effect on future entitlements
Paying yourself a £Nil salary will mean you do not pay any National Insurance. However, not paying NI contributions could affect your entitlements later down the line, including the state pension and a number of other state benefits.
Investigations by HMRC
If you’re not taking any salary from your business, it’s possible that HMRC will argue that the dividends paid or declared incorrectly are in fact ‘salary in disguise.’ In this case, HMRC will seek to tax the dividends as salary.
Corporation Tax Relief
Any salary that your company pays to you will qualify for Corporation Tax relief. This means that if your company pays you £8,424 it will save £1,600 in Corporation Tax.
This combined with the fact that this income is tax free for you, as it’s within your personal allowance, makes a nominal salary very tax efficient.
Finding a balance that’s right for you
Of course, striking the right salary/dividend formula will be entirely dependent on your individual circumstances – there isn’t a one-size-fits-all solution. Many factors will need to be considered, such as:
- Your age
- Likely length of career
- Projected income levels
- Views of pensions planning and saving
- Family status
- Income from outside the business
- IR35 risk status
- Cash requirements to fund lifestyle
With all these factors to bear in mind, it can really help to turn to the professionals to help in your decision, like the team here at Intouch. We’ll help you get your business up and running and can advise on how best to withdraw income from your company. If you’d like to find out more, call our experts on 01202 375293. And, in the meantime, take a look at our new guide on combining salary with dividends.
This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.