Owners of family and personal companies will want to extract profits from them as necessary to meet personal bills. There are various ways of doing this including taking a salary or paying a bonus, declaring dividends, making pension contributions and taking profits in the form of benefits in kind.
When seeking to extract profits in a tax efficient manner, a popular strategy is to pay a small salary and to extract further profits in the form of dividends. However, while the salary should be at least equal to the lower earnings limit (set at £6,240 for 2021/22), the optimal salary will depend on circumstance.
Where the employment allowance is not available (as is the case for a personal company where the sole employee is also a director), the optimal salary is one equal to the primary threshold, set at £9,568 for 2021/22.
However, if the employment allowance is available (as may be the case for a family company with two or more employees), the optimal salary is one equal to the personal allowance, set at £12,570 for 2021/22. In each case, it is assumed that the personal allowance is available to shelter the salary paid.
Once the level of the optimal salary has been reached, it is more tax effective to extract further profits as dividends. Although dividends are paid out of post-tax profits and have suffered corporation tax at 19%, they benefit from lower income tax rates and are not liable to National Insurance contributions.
Remember, all taxpayers, regardless of the rate at which they pay tax, benefit from a dividend allowance of £2,000 for 2021/22. No tax is payable on dividends covered by the allowance.
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