Congratulations! Starting your own company is a huge step for anyone to make, and it can be an extremely rewarding one. There are many reasons someone might want to start a company, from passion to profit, but almost everyone who starts their own company also wants to make a living out of it. So how can this be done?
The first thing to say is that it can take a while for a business to get off the ground and create enough profit to pay those involved. Once that happens however, there are two principle methods for people to be paid from their own company – Salary and Dividends.
A salary, by definition, is an agreed contractual payment by a company to its employees. If you complete work for your company, even if you’re a director, you can pay yourself a salary as an employee. To do this, the company must be registered as an employer with HMRC. This method is the most reliable, as a salary is the most common form of income for an individual, and it can also incorporate business expenses and benefits. Payroll is also classed as a business expense when calculating your Corporation Tax.
However, salaries are subject to Income Tax and National Insurance deductions. If you earn more than £12,570 in the 2021/22 tax year* you’ll be taxed at an increasing rate depending on how much your total income is, up to a rate of 45% on income over £150,000. On top of this, the employer must pay both employee and employer National Insurance contributions, which on balance can make a larger salary an inefficient option for you and your business.
Dividends are payments that can be made by a company to its’ shareholders from any remaining profits after tax. Paying yourself with dividends means that your income could potentially be higher as opposed to a fixed salary every month. The company won’t have to pay income tax and national insurance on dividend payments so its tax liabilities and costs will be substantially lower for every pound you receive as an individual. Plus, paying yourself in dividends can be a keen motivation for performance since your compensation can increase in line with your company’s profits.
However, since they’re paid from your company’s profits after tax, they’re not a guaranteed way of earning money, and they can’t be counted as business expenses when calculating your Corporation Tax. In fact, dividends are applied after the 19% Corporation tax is deducted on company profits, and dividends that total more than £2000 in a single tax year are taxed additionally. So provided you have no income other than dividend, you’ll be taxed 7.5% on anything between £2,000 and £50,270, 32.5% between £50,270 and £150,000, and 38.1% on anything over £150,000, which combined with Corporation Tax can make dividends potentially more expensive than salaries. However, these figures are subject to change if you have other income sources to consider within these tax bands, Ezyco can help guide you with these calculations.
But there’s a happy medium…
Many directors who are also shareholders of companies choose a third method to get paid – paying themselves a smaller salary and topping it up with dividends. There are some clever calculations that can be made to work out what proportion could be salary and how much could be dividends, and some pros and cons to assess whether you or your business should foot the tax bill. This is where advice from an accountant can prove invaluable.
Want to look more into your options? Get in touch with Ezyco Accounts today!
*This figure may be higher or lower depending on your circumstances or if you read this article in a subsequent tax year