There are numerous benefits associated with the incorporation process, which turns a sole trader or partnership into a private limited company (LTD) or limited liability partnership (LLP).
Probably the biggest benefit is the protection that the directors and owners of limited companies receive from business debts. However, while the act of incorporation provides valuable protection, it also makes the process of taking money out of the company a lot more complicated.
A limited company is a separate financial and legal entity in the eyes of the law. That means you can’t simply take money out of the company’s bank account as you would as a sole trader. Every penny you take out of the company must be properly recorded in the company’s accounting records. Although it may require a little more work to take money out of a limited company, it can be more tax efficient. That means, once you understand how the process works, you can maximise your take-home pay by taking advantage of the different payment options that are available.
In this guide, we’ll break down the four ways to take money out of a limited company and provide details about the specific procedures for each.
What Different Ways can you Take Money out of a Limited Company?
There are four different ways you can take money out of the company’s bank account and pay it into your own. They are:
- Dividend payments
- Director’s loan
- Reimbursement of expenses
You have no obligation to take any money out of your limited company at all, and in the early days, when it’s still establishing itself, you may choose to reinvest all the profits in the business. However, over time, you’ll need to take money out of the company to live. By using the right combination of the methods above, you’ll be able to do so in a tax-efficient way that suits your specific needs.
How to Take a Salary out of a Limited Company
Paying yourself a salary is the most straightforward way to take money out of a limited company. It’s unlikely that you’ll take the majority of the money you earn as a salary as it’s not the most tax-efficient way to do so. However, paying yourself a monthly salary up to the value of the Class 1 National Insurance threshold of £8,632 for 2019/2020 makes a lot of sense. It will ensure you qualify for state pension and benefit entitlements without incurring a personal tax liability. That means, in tax terms, it’s free money. The rest of the money you take out of the company can be in the form of dividends.
To pay yourself a director’s salary, your company must be registered with HMRC. If you pay yourself a salary above the National Insurance or tax-free personal allowance threshold (£12,500 for 2019/2020), you will have income tax and National Insurance contributions deducted from your salary every pay period via the PAYE system. You will also have to make monthly submissions to HMRC to confirm your salary information.
How to Take Dividends out of a Limited Company
If your company is making a profit, you can choose to keep the money in the business and reinvest it or withdraw it in the form of dividends to supplement your income. Dividends can only be taken out of a limited company once deductions for corporation tax have been made. Dividends must be paid from profits for the year or undistributed profits from previous years. If you take a dividend out of a loss-making company, you could receive a financial penalty and even face an investigation from HMRC.
Dividends are issued based on the proportion of the company you own as represented by your shares. If you are the sole shareholder in the company, you can take all the profit out of the company if you choose to do so. The first £2,000 of annual dividend income is tax-free. This is over and above your personal allowance. Importantly, no income tax or National Insurance contributions are payable on dividends. However, you will have to pay tax on dividend income over your personal allowance at the following rate:
- Basic rate – 7.5 percent
- Higher rate – 32.5 percent
- Additional rate – 38.1 percent
In order to pay yourself a dividend as a company director, you must hold a board meeting to declare the dividend and minutes of the meeting must be taken. In practice, if you’re the only director and shareholder, you’ll simply need to record the fact that you issued a dividend on a certain date and keep a record of the payment. Limited companies can issue dividends at the end of the financial year and at various points throughout the year. The payment date should be agreed at the board meeting.
How to Take a Director’s Loan out of a Limited Company
A director’s loan is another way to take money out of a business, but the procedure must be handled extremely carefully as it’s inherently risky. A director’s loan can be used by a company director to:
- Lend personal funds to the company to purchase an asset, invest in a new opportunity, etc., in which case, the director’s loan account will be ‘in credit’.
- Borrow money from the company that exceeds the amount you have put in, in which case, the director’s loan account will be ‘overdrawn’.
Every transaction in the director’s loan account, whether the director lends money to or borrows money from the business, must be accounted for in the director’s loan account and recorded in the company’s balance sheet. It should also be included in the company tax return and the director’s self-assessment tax return.
If you have lent the company money and your director’s loan account is in credit, the money can be reclaimed at any time without any personal tax liabilities. If you take money out of the company that exceeds the amount you have put in, there may be tax implications.
If directors borrow money from their company but repay the sum within nine months and one day of the accounts reference date, they will not have to pay any tax. If the amount remains outstanding, Section 455 tax will be charged at the current rate of 32.5 percent, which will be paid by the company alongside its corporation tax. The S455 tax will be reimbursed once the loan has been repaid. If you have borrowed more than £10,000 from your company, the sum must also be declared on the director’s self-assessment tax return and income tax must be paid at the appropriate rate.
If the loan is written off by the company, it must be declared on the director’s self-assessment tax return so the correct rate of income tax can be charged.
Read more about the potential implications of an overdrawn director’s loan account.
How to Take Expenses out of a Limited Company
There are likely to be plenty of times when you pay for business expenses out of your own pocket rather than using company funds. Although it will not represent a large portion of your income, there is a tax-free method to recoup the money you spend.
Business expenses can be reclaimed as long as the cost was incurred ‘wholly and exclusively’ for the purpose of business. To reclaim this money, you will need to keep receipts (receipts must be kept for at least six years), complete claim forms and record the expense refunds in company accounts. Your business will also receive tax relief on these expenses.
Examples of the expenses you can claim include:
- Computer and office equipment
- Mileage and parking charges
- Travel and accommodation
- Mobile phones
- Training fees
- Postage costs
Any expenses you’ve paid for personally can be reimbursed by your company every month when you receive your salary or at any other interval that’s convenient. At the end of the tax year, you must complete form P11D to show much money you have claimed in expenses. These expenses should also be included on your self-assessment tax return.
What’s the Best way to pay Myself as a Company Director?
With a number of different options available, it’s not always easy to know what the best way to take money out of your limited company is. Most directors find that taking a low salary supplemented by dividends is the most tax-efficient way to operate. However, having the option to take a director’s loan can provide additional flexibility as long as the process is handled correctly.
If you would like advice about an overdrawn director’s loan, are being chased by HMRC or are unable to take money out of your company due to a lack of profit, please get in touch with our team today. We’ll provide a free, no-obligation consultation to help you understand your position.