Short and Sons Accountants have revisited the most effective way for a director to extract profits from their small limited company. We believe it's best to remain within the basic tax rate, so will be extracting with a limit of £50,270 to ensure the least amount of tax possible is paid.
Historically, withdrawing the personal allowance (£12,570) through payroll and taking the rest through dividends was the most tax-effective way to extract profits from a company. However, the introduction of 25% corporation tax with marginal relief and a reduction in Class 1 National Insurance Contributions (NIC) has presented a new way to save on tax.
It's important to note that the methods described in this article will not work for a limited company with a sole director who has no employees, as the director cannot claim employers' National Insurance relief, making the extraction methods much less effective.
This article will show the different tax implications of using payroll vs dividends to extract profits for companies with profits of £50,000, £75,000 and £100,000. By the end of the article, we will know the cheapest way to extract profits in the 2023/2024 financial year.
All our scenarios will aim to extract £50,270, as well as make use of the £12,570 personal allowance and the £1000 dividends allowance, ensuring maximum tax savings.
Scenario 1 - £100,000 Company Profit
Method 1 - Dividends
£12,570 Payroll
£37,700 Dividends
£12,570 payroll reduces company profits to £87,430, and the corporation tax paid on that (after marginal relief) would be £19,418.95. Then, there would be £0 tax paid on both the £12,570 payroll and £1000 of the dividends. However, a further £3211.25 would be paid on extracting £36,700 through dividends due to 8.75% dividend tax.
Method 1 tax: £19418.95 (corp tax) + £3211.25 (personal tax) = £22,630.20
Method 2 - Payroll
£49,270 Payroll
£1000 Dividends
£49,270 payroll reduces company profits to £50,730; the corporation tax paid on that would be £9693.45. Then, just as in the previous example, no tax would be paid on £12,570 payroll or £1000 dividends. However, £10,276 would be paid on the remaining £36,700 payroll since 20% income tax would be due in addition to 8% Class 1 NIC.
Method 2 tax: £9693.45 (corp tax) + £10,276 (personal tax) = £19,969.45
Scenario 2 - £75,000 Company Profit
Method 1 - Dividends
£12,570 Payroll
£37,700 Dividends
£12,570 payroll reduces company profits to £62,430, on which £12,793.95 corporation tax will be due. Then, after the £12,570 payroll and £1000 dividends, which are tax-free, £3211.25 dividend tax will be due on £36,700 dividends.
Method 1 tax: £12,793.95 (corp tax) + £3211.25 (personal tax) = £16,005.20
Method 2 - Split to 50k
£25,000 Payroll
£25,270 Dividends
The idea here is to use payroll to reduce the company profit to £50,000, because at that figure corporation tax is only 19%, and then extract the rest through dividends. Getting your company profit down to £50,000 via payroll and putting the rest through dividends is the most effective way to save on tax whilst limiting yourself to extracting £50,270. The £25,000 payroll reduces profit to £50,000, resulting in £9500 corporation tax. Then, after the tax-free personal and dividend allowance, £3480.4 will be due on the remaining £12430 payroll and £2123.63 will be due on the remaining £24,270 dividends.
Method 2 tax: £9500 (corp tax) + £3480.4 (personal tax) + £2123.63 (personal tax) = £15,104.03
Method 3 - Payroll
£49,270 Payroll
£1000 Dividends
After the £49,270 Payroll, the company profit would be reduced to £25,730, on which £4888.7 corporation tax would be due. Then after the dividend and personal allowance are considered, £10,276 will be due on the £36,700 Payroll.
Method 3 tax: £4888.7 (corp tax) + £10,276 (personal tax) = £15,164.70
Scenario 3 - £50,000 Company Profit
Method 1 - Dividends
£12,570 Payroll
£37,430 Dividends
£12,570 payroll reduces company profits to £37,430, resulting in £7111.7 Corporation tax. Then, after the dividend and personal allowance, £3187.63 will be due on the remaining £36,430 dividends.
Method 1 tax: £7111.7 (corp tax) + £3187.63 (personal tax) = £10,299.33
Method 2 - Payroll
£49,000 Payroll
£1000 Dividends
£49,000 Payroll reduces company profit to £1000 which incurs corporation tax of £190. Then, after making use of the dividend and personal allowance, there will be £36,430 payroll to pay tax on, which will cost £10,200.40.
Method 2 tax: £190 (Corp tax) + £1,200.40 (personal tax) = £10,390.40
Now, we have used different methods of extracting profits from companies that are making different amounts of profits. We do not extract more than £50,270 to pay the least tax possible. The most efficient way to extract the profits is to reduce the company's profits to £50,000 via payroll (if possible) and then take the rest via dividends. You always want to ensure you use the personal and dividend allowance no matter the profit level. If your company's profits are too high to be reduced to £50,000, as in scenario 1, then the only dividends you should take is the £1000 dividend allowance, and the rest should be through payroll. Following these smart steps will reduce your tax bill, meaning more money in your pocket!
Short and Sons Accountants always focus on reducing tax bills, adhering to regulations, and offering fair prices. If you want to switch to an accountant you can trust, contact us today or visit our website.