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How do I pay myself as a Director of my Limited Company?

Friday, May 8, 2020
By Cheryl Sharp
How do I pay myself as a Director of my Limited Company?

This has got to be one of the most common questions we get asked by new directors.  The simple answer is through a mix of salary and dividends.  However, what does this mean?  Why a small salary?  What are dividends?  We do it this way to make you as tax efficient as possible - which in real terms means paying as little tax as possible (but staying legal)!

What will my small salary be?

The amount of your salary depends on how many of you there are.  If you’re a sole director with no staff then you’ll be on a salary of £9500 for the 20/21 tax year.  This takes you to the NI threshold, which means you’ll get your tick for the year on your NI record (for your state pension), but you’ll pay just a small amount (Approx £98) of employer’s NI (and we work this so it’s a one off payment in March 2021 so you don’t need to worry about it during the tax year).

If there are two of you then you’ll be entitled to the Employment Allowance (a £4k contribution to your employer’s NI bill) so you’ll be on a salary of £12,500 for 20/21, which is the personal allowance.  You’ll be paying a small amount of NI each month (around £60) out of your salary, but your employer’s NI will be covered by the Employment Allowance.

Please note that this is generalised, and staff will affect which salary is right for you.  We will put you on the right salary level for your circumstances to make you as tax efficient as possible, but these are the main two circumstances for the majority of our directors.

We run payroll monthly, file a return with HMRC and advise the amount to pay yourself (any staff) and to HMRC.  We file payroll returns through Xero Payroll and your payslips are then available on the Xero Me app.

Your salary is a tax deductible expense.

And do I then top up with dividends?

Any money you take out of the business on top of your salary will be classed as dividends.  Dividends are taken out of your profit after corporation tax, so they are not an expense.

Dividends are taxed as part of your tax return.  You get a £2k tax free allowance, on top of your personal allowance (so in effect you can earn £14,500 in the 20/21 tax year before you start paying tax).

Any dividends over your personal and dividend allowances are taxed at 7.5% up to a total of £50k income, and 32.5% over the £50k total income mark.

How do I actually make the payment?

There is no right or wrong answer to this one, everyone is different.  After years of employment my preference is making a payment to myself at the end of each month which is a mix of salary and dividend.  It’s a regular amount then and makes it easy to budget, both for the business and you personally.

Some clients pay themselves the monthly salary amount at the end of each month, and take top up dividends as and when they need them.

Some clients like to just take money out as and when they need it, with no regular pattern.

And some are anywhere in between!  Whatever works for you is fine :)  The only thing I would say is you shouldn’t use your business account (and bank card) as your personal account, and card.  Always transfer the money into your personal account then spend from there.

What is a director's loan account?

This is where we record all the payments to yourself.  Anything you pay for personally, or money you put into the business, we’ll record in here too.  We’ll also record here the use of home amount we include in your accounts, and any mileage expenses you put through the business too.

So effectively we offset any payments to you against the expenses you’ve paid for and money you’ve put into the business.

When are dividends made official?

At the end of your company’s financial year we make the balance your official dividend amount.  

So let's say you’ve paid yourself £10k in dividends throughout the year, but have paid out £2k of expenses then that gives you a balance of £8k that we declare as your official dividend for the year. 

This is done at your company's financial year end.  Depending on when your year ends depends on which tax year your dividends fall into. 

For example, let's say your financial year is 1st January 19 - 31st December 19, then your dividends will be made official as of 31st December 19 and will be in the 19/20 tax year and need to be included in your 19/20 tax return.

However, if your financial year is say 1st July 19 - 30th June 20, then your dividends will be made official as of 30th June 20 and will be in the 20/21 tax year and therefore your 20/21 tax return.

How do I prove my dividends?

Your dividends won’t show on payslips.  At the end of the year as part of preparing your accounts we will also prepare a dividend voucher which will confirm your dividend amount for that year.

How much can I take in dividends?

As I mentioned before dividends are taken out of profit after tax, so we need to make sure you don’t take more dividends than there is profit.

In the early days of your business this can be hard to predict, and if your business fluctuates it can be quite difficult too.  Therefore we can work with you to work out a rough estimate to start with.  We monitor throughout the year the balance on your directors loan account to make sure you don’t take out too much of the business.  Each quarter we prepare a report and include this balance, and will advise if you’re able to take more, or need to start cutting back a bit.

What if I take too much out?

As we monitor this balance throughout the year, and include in our quarterly report we will be able to spot quite quickly if you’ve taken too much out of the business.  At this point we would look at a few different options.  You could cut back on the amount you’re taking, you can repay some of the money back into the business (if you still have the cash of course!).  We can also look at increasing your salary - as your salary is a business expense we can increase your salary as required to ensure you don’t take too much out as dividends.  This may mean you pay a little more in tax/NI, but is more cost effective.

You can have a small balance at the end of the year which can be classed as a loan, you have 9 months and 1 day to repay this ‘loan’ either by increasing profits over the next 9 months to cover it, by increasing your salary as we mentioned earlier, or by repaying it, like you would a loan.

As long as the balance is either repaid in full, or there is less than £5k outstanding at the end of the year then this will not cause any problems.

If the balance is over £5k and cannot be repaid within the 9 months and 1 day period then you will need to pay an additional 32.5% in corporation tax on the loan amount.  This is also known as S455 tax).  This is why it would be cheaper to increase your salary to bring the loan down.

However, once the loan amount is cleared then HMRC will repay the S455 tax paid - but you still need to have the cash there to pay the tax in the first place.  Therefore we will try all other options first to avoid paying this additional tax.

I hope this answers your questions on paying yourself, but if you have any further questions, or would like a better understanding on your own personal situation please do not hesitate to contact us on hello@pinkpigfinancials.co.uk.