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Tax-Efficient Profit extraction



Optimal salary 2022/23

Where a business is operated as a personal or family company, profits will need to be extracted from that company if they are to be used in a personal capacity. There are various ways of extracting profits, but from a tax perspective, not all extraction methods are equal.


A popular and tax-efficient strategy is to take a small salary and to extract any further profits as dividends where these are needed outside the company.


The optimal salary will depend on personal circumstances and whether the employment allowance is available. However, it is beneficial to pay a salary that is at least equal to the lower earnings limit for National Insurance of £6,396 for 2022/23 to ensure the year is a qualifying year for state pension purposes (unless the recipient already has the 35 qualifying years needed for a full state pension).


Where the employment allowance is not available (as is the case for a personal company where the sole employee is a director), the optimal salary for 2022/23 is equal to the annual primary threshold of £11,908, provided that the director has at least £11,908 of his or her personal allowance available to shelter the salary from tax.


Where the employment allowance is available, the optimal salary for 2022/23 is equal to the personal allowance of £12,570, as long as this has not been used elsewhere.


Dividends

Once the optimal salary has been paid, if further profits are available and are required outside the company, it is more tax-efficient to take these as dividends. Remember, dividends can only be paid if there are sufficient retained profits from which to pay the dividend, and must be paid in proportion to shareholdings (although the use of an alphabet share structure can provide valuable flexibility).


Dividends can be paid tax-free where they are sheltered by any remaining personal allowance or by the dividend allowance (set at £2,000 for 2022/23. Thereafter, they are taxed at 8.75% where they fall within the basic rate band, 33.75% where they fall within the higher rate band and at 39.35% where they fall within the additional rate band.


Using an alphabet share structure and paying dividends to family members to utilise unused dividend allowances and basic rate bands can efficient.

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