Are you extracting profits from your family business tax efficiently?
There are a number of ways to extract profits from your family business whilst keeping your eye on tax efficiency.
Subject to other income arising outside of the business, director/shareholders can take up to £12,500 per annum without giving rise to a PAYE liability. Employees NIC (at 12%) and Employers NIC (13.8%) is payable on earnings above £8,632.
For 2019/20 employers can claim a £3,000 employment allowance to be set against employers’ NICs if the director of that company is not the only employee.
Where dividends fall within the basic rate band, which is £37,500 for 2019/20, the tax rate is 7.5% for dividends in excess of the £2,000 dividend allowance. So if, for example, a husband and wife are equal and the only shareholders and they have no income other than the £12,500 salary, each would pay tax of £2,663 on dividends of £37,500.
The tax on dividends gets more complex where the dividends become subject to higher rate or additional rate tax, so it’s important to get professional advice. Any tax due for the year to 5 April 2020 would be due on 31 January 2021.
It’s important to remember that dividends are not counted as a business expense when calculating your Corporation Tax and that it is illegal to pay a dividend if your company does not have sufficient profit after tax available to cover the dividend amount.
Shareholders and directors should review their salary and dividend mix each tax year.
Pension contributions are a useful way to extract profits from your business while still benefiting from tax relief. Whether it’s the individual or the company itself who pays into the pension, the money isn’t treated as a benefit so it’s very tax efficient.
£40k is the limit individuals can pay into a pension each tax year, reduced for anyone with an annual income over £150k. Personal pension contributions are restricted to 100% of an individual’s relevant earnings so they need to be carefully considered alongside other profit extraction strategies.
Pension contributions made by the company, rather than the individual, reduce the business’s overall profit so there’ll be less corporation tax to pay and, unlike personal contributions, there’s no limit on how much a company can pay into a pension scheme.
Paying into a pension is both a short term way of extracting profit and a long term way of planning for retirement, and can be a great way to make the most of your business’s income.
Other profit extractions such as spouse, children’s and other family members’ wages or pension contributions are also possible, although they must be justified at market rate.
It’s traditionally been suggested that directors and shareholders should extract profit by paying themselves as low a salary as possible and supplementing the remainder of their income through dividends which are usually exempt from National Insurance Contributions (NICs).
However, this strategy has wider implications than just tax and we can discuss the different options to make the best plans for extracting profits from your family business in the most tax efficient way.
The information was correct at time of publishing but may now be out of date.