We outline how much tax a limited company should pay but first an introduction.
Introduction to limited company tax
At Wagners, we meet owners of a range of companies in all shapes and sizes and from different sectors.
Yet all have one common concern.
They all want to ensure that they pay the right amount of tax, ensuring that they honour their obligations under HMRC guidelines while still keeping their cashflow healthy.
Many companies worry that their tax liability may be disproportionate to their income, and HMRC and the tax system not sympathetic to the ups and downs of normal business trading, putting a stranglehold on their cash flow and endangering their operations.
Many of our clients find that setting themselves up as a limited company can reduce their tax liability, saving them money and ensuring that their cash flow remains healthy.
Yet, while it may be advantageous in this regard, there are still caveats.
Getting paid when you are running a business is much more complicated than when you are an employee.
Likewise, while you may enjoy a smaller tax liability this is undoubtedly more complicated to manage.
Fortunately, we are on hand to simplify your understanding of the tax liability for UK limited companies and allow them to make well-informed decisions about all their tax position.
So, let’s take a look at tax for limited companies…
What’s the tax liability for a limited company?
Sole traders are obliged to pay income tax and National Insurance.
Matters are slightly different for limited companies.
Instead, these pay a corporation tax rate on their profits.
Your profits are your annual income less your allowable costs.
The current corporation tax rate for the 2019 tax year is 19% but will drop down to 18% for the 2020 financial year.
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How do limited companies pay corporation tax?
Those who are used to paying a combination of income tax and National Insurance (either as sole traders or employees), may be unfamiliar with how limited companies pay corporation tax.
Corporation tax is different in a couple of fundamental ways.
For example, it is charged at a flat rate.
You are charged the same amount regardless of the size of your profits.
There is no tax free allowance as there is with income tax and different rates do not apply in relation to your earnings.
Your corporation tax remains 19% whether your make £10,000 profit or £100,000 profit in a financial year.
How do I get paid through a limited company?
In the eyes of the law, sole traders are their business.
They have complete autonomy over the business’s income and they can take money from the business’s profits whenever they please.
When it comes to limited companies, the law regards the company as entirely separate from the person (or persons) who founded/owns them.
Thus, when the company makes money, it is the company’s money and not the company’s owner’s.
Company owners cannot legally withdraw funds from the company whenever they wish without some strict procedures.
“Leo and his team have always been a great help over the years. I’ve often found that Leo has a keen recall of the past history of my business and has always provided an excellent service.
I can heartily recommend the team at Wagner.”
Stewart LawrieSoftware Developer, SWIP
So, how do you get paid when you own a limited company?
There are three ways;
- You can pay yourself a salary.
- You can declare a dividend, or
- a combination of both
Let’s take a look at the logistics of both options so that you can make an informed decision as to which best suits your needs.
How do I pay myself a salary through a limited company?
In order to pay yourself a salary through your limited company it is wise to go through the proper channels with HMRC;
- First of all you should declare the limited company as an employer by registering with HMRC.
- Download HMRC’s PAYE software tools for businesses to set up Pay As You Earn (PAYE) tax for your business.
- Transfer your net salary from your company bank account into your personal bank account (just like you would an employee).
- Submit electronically the information to HMRC immediately after the transfer using your HMRC approved tools.
However, it’s important to remember that as a business owner you must juggle the tax implications for running a limited company not just for your business taxes, but for your personal taxes.
What are the tax implications of paying myself a salary?
Like any employee, your salary will be subject to National Insurance and income tax liability.
However, it’s worth noting that your company will be able to declare your salary as a business expense.
Your company may also have to pay employer’s National Insurance on your behalf.
Some business owners can circumvent this extra liability by paying themselves a salary that is just below the threshold for National Insurance.
For the year to 5 April 2020 this threshold is £8,632 a year. This means that you will still get the benefits of national insurance without you or your company having to pay it.
It is also within the lower earnings limit and well within your personal tax-free allowance, which for the year to 5 April 2020 is £12,500.
Needles to say, £8,632 is not enough for most to be able to live on comfortably.
This is why many business owners supplement a lower salary with business dividends…
Dividends and shareholders
If this is your first attempt at running a limited company you may be unsure about dividends and their tax implications.
Even seasoned entrepreneurs would be wise to seek guidance when it comes to taking dividends for themselves.
What is a dividend, and why is it important?
In its simplest terms, a dividend is a share of the company’s profits, which is paid to its shareholders.
A shareholder is the legal term for any person who owns part of a company (or even the whole thing).
How do I take a dividend?
The most important thing to remember when it comes to dividends is that they are paid out of the company’s profits… so, there has to be some.
Take a look at your company’s financial situation.
Dividends can only be taken from after-tax profits (these are known as ‘retained profits’).
The next step is to create a dividend voucher which includes the company name, the monetary amount of the dividend and the name of the person receiving the dividend amongst other information.
We are well versed in providing help, advice and support for business owners who are unsure about creating dividend vouchers.
The next step is to transfer the dividend into your personal account from your business account.
What are the tax implications of paying myself a dividend?
Dividend payments are, unsurprisingly, classified by HMRC as taxable income.
It is a good idea to limit your dividend payments to once or twice a year as more frequent payments may bring unwanted attention from HMRC.
Fortunately, because dividends are deducted from the company’s after-tax profits they do not affect the business’ tax position.
The only tax implications which must be borne in mind are personal tax implications.
Dividends of up to £2,000 are not taxed in the year to 5 April 2020.
Dividend plus salary (minus the tax-free £2,000) between £12,501 and £50,000 is charged at the basic rate of 7.5%.
Where dividend plus salary is between £46,351 and £150,000 it is taxable at a higher rate of 32.5%.
Where dividend plus salary exceeds £150,000 the tax rate climbs to 38.1%.
Where total personal earnings exceed £100,000, the personal allowance of £12,500 gets reduced on a sliding scale for personal earnings to £110,000.
Can’t I just pay myself entirely in dividends?
Because dividend tax rates are much lower than those for income tax, we understand that it may be tempting not to even take a salary.
However it is not quite that simple and it is worth taking something by way of a wage.
If you don’t take a salary this means that you will fall outside the lower earnings limit for National Insurance and this means that while you won’t have to pay National Insurance, you won’t be able to benefit from it either.
This year won’t add any entitlement to your state pension entitlement or statutory sick/maternity pay.
What’s more, HMRC are likely to view it as suspicious if you do not take a salary and could apply extra scrutiny to your business and personal finances.
Need help? Contact Wagners today!
We understand that tax planning for limited companies can be confusing.
That’s why we’re always on hand to render expert help and advice to our clients.
If you need help navigating the legalities and technicalities of UK company liability call us today.
A member of our team will be delighted to help you.