Sunday, January 23, 2011

Extracting profits from your company

One of the benefits of running your own company is that it gives you a lot of flexibility when it comes to extract profits from the firm. As a sole trader, whatever profit you make is taxed immediately at a rate that depends on the amount of profits but that can now be as high as 58% if we include Class 4 National Insurance Contributions.

If you own a limited company however you have a lot more flexibility and if you are not needing the cash now, you can reduce your tax considerably. In most cases it's just a matter of following those simple steps:
  1. If, as a director, your only revenue comes from your company, you can extract up to the personal allowance without paying personal taxes and that cost is tax deductible for your company. That amount is currently £6,475 but it should increase up to £10,000 in the next few years. Keep in mind however that if your annual salary is £5,715 or more you will incur some national insurance contribution costs. This is why most directors extract just that amount every year: no tax, no NI and allowable expense for the company.
  2. Obviously you will probably need more than that to live on. The next step is to extract profits as dividends. Dividends are paid after corporation tax so you will have incurred 21% tax at the company level on that profit (if your company's turnover is below £300K) but you will not pay personal taxes for the first £37,400. Extracting money as salary instead would have cost more than twice as much because of the Class 1 National Insurance Contribution of around 24% . 
  3. After that, choices abound as it will depend on the amount of money you need and when. One option is pension contributions as it's quite tax efficient even if the last budget has curtailed a lot of the benefits. That money is locked until retirement however. Another option is to just leave money into the business and realize the profit upon resale of that business. Because of the entrepreneur's relief benefit, you will then get an effective personal tax burden of just 10%.
Here is a table that summarizes the different blended tax rates based on company size, personal taxation bands and the corresponding tax year:



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