Many contractors choose to become a limited company director, as it can be significantly more tax-efficient than working through an umbrella company, or as a sole trader. As a limited company director, you have access to a variety of methods to maximise your take-home pay.
So, after taking the leap into contracting, the last thing you want to do is give away too much of your hard-earned cash by working in a non-tax efficient way. When it comes to paying yourself, there’s a few ways you can do this:
- Director’s loan
- Reimbursement of expenses
- Dividend payments
Of course, the method must be right for you and your circumstances. To help you make a well-informed decision, we’ve explained everything you need to know.
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As a permanent employee, you earn an annual salary and typically get paid once per month. This is subject to Income Tax deductions and National Insurance contributions, as well as any other deductions that apply to you. If you are a limited company director, it's your responsibility to draw your own salary.
Transferring your salary from your business bank to your own personal account is relatively straightforward. Most of your income won't usually come from a salary, but it's a useful method in providing you with a monthly wage.
To begin paying yourself a salary, your limited company must be registered with HMRC.
The personal allowance is currently set at £12,500 (2019-20). Providing you have no other means of income throughout the tax year, it's possible to draw a salary up to this threshold without having to pay Income Tax.
As the director of your limited company, a director's loan allows you or a family member to either borrow money from the business, and also the business to borrow from your personal funds.
This loan must be repaid to your business account within nine months of the end of the financial year, to avoid an additional repayable tax charge (S455 charge).
The tax liabilities and any interest payable depend on the balance and the length of time for which the account is overdrawn. If the company owes anything to a director, then that amount can be withdrawn without incurring tax liabilities. Any transactions that take place must be recorded, in a director's loan account. This record must also be replicated on the balance sheet of your annual accounts.
Reimbursement of expenses
Any cost which you have incurred personally, which has been made exclusively for the purpose of your business, can be claimed as a legitimate business expense. Whilst your business will receive tax relief on these expenses, you will also be able to reimburse yourself personally.
The main bulk of these expenses typically include business miles, insurance and equipment, but can include any necessary costs. Although business expenses are unlikely to make up a large portion of your take-home pay, this is a useful way to maximise your tax efficiency.
Once your company has started making a profit, these profits will be subject to Corporation Tax of 19% (2019-20), but the remainder can be paid to directors and shareholders in the form of dividends. This is a way of dividing up the company's profits and distributing them based on the percentage of the company they own.
Dividends can be paid at any point during the financial year, providing there are profits available. It is entirely your choice as to when and how much you pay.
To take dividends out of your company, you will firstly need to hold a meeting with your company directors to declare the dividend. A dividend voucher must also be given to each shareholder, outlining the dividend paid.
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