As a director of a newly formed private limited company, you have many important decisions to make, one of which is how best to pay yourself when you start to turn a profit. Making the right decision regarding how to pay yourself as a director is important because this can determine how much pay you receive, the tax that you will pay and the extent of any administration required. In this article we will outline three of the most common ways in which you can pay yourself as a small company director, the advantages and disadvantages of each and any other considerations you should bear in mind.
What are the most common ways of paying yourself as a company director?
As a director of a small company, you can decide between paying yourself as a salaried employee through the PAYE scheme, through dividends, or through a mixture of PAYE salary and dividends. For most small company directors in the UK, the latter option of paying themselves a salary and dividends is the most popular, for reasons that we will explain below.
Option 1) Receiving a salary as an employee
As a small company director, you have the option to take all or part of your pay through a salary as an employee. For many small company directors this is the most straightforward way to manage their remuneration. Paying yourself a salary requires registration with the HMRC’s “Pay As You Earn” (PAYE) scheme for the purposes of paying tax on your income. Once registered for PAYE you will be required to submit information on each payment that you receive through the HMRC’s Real Time Information (RTI) – this is referred to as a Full Payment Submission (FPS).
Accounting software can be used to send the required information to HMRC, or you can instruct your accountant or a third-party payroll provider to handle this for you. Alternatively, you can download the HMRC’s free “Basic PAYE Tools”. This software can perform most payroll tasks, including the calculation of the tax and National Insurance due and sending this information to HMRC.
When your PAYE payroll is run you will receive a payslip detailing your gross pay and any deductions made for income tax and national insurance, in the same way that you would as an employee of another company.
It is important to ensure that your RTI FPS return is made on time, otherwise you may receive an automatic fine. The HMRC website states: “HMRC will send you a late filing notice if you’ve paid any employees and do not send an FPS or send one late. They can also charge you a penalty unless you have a valid reason for reporting late”.
Pros and cons of using PAYE to pay yourself:
|Reduces your corporation tax bill because your salary is paid from pre-tax profits.
|Not as tax efficient as receiving your pay through dividends.
|Not as tax efficient as receiving your pay through dividends.
|There is the risk of a fine if you do not submit the RTI information on time.
|No extra company administration required:
Straightforward process that can be automated or completed by a third-party.
|Because you need to submit information to HMRC before you can pay yourself, you cannot simply pay yourself when you like (i.e. at different times during the month).
|No additional personal tax bills to pay.
Option 2) Receiving a dividend
Companies issue dividends as a way of distributing their earnings to shareholders. As a company director you have the option to pay yourself partly or wholly through dividends. To do so you must be a shareholder (remember that being a director does not necessarily mean you are a shareholder) and the company must be making enough profit to cover the dividend payments.
Many company owners/directors who work also for an employer from whom they receive a salary through PAYE choose to receive a dividend from their own company since this avoids the need to pay national insurance twice.
When considering whether taking dividends is right for you it is important to consider the following:
- If your profits are highly variable, this may mean that your income is unpredictable.
- You will need to pay corporation tax on your profits before dividends are paid out
- If you accidentally take a dividend when you have not made a profit then you will need to take out a director’s loan, which may need to be repaid with interest.
- The rate of dividend tax that you must pay rose from 7.5% to 8.5% in April 2022.
The current dividend income tax bands are as follows:
- £0 – £12,570: 0% (Personal Allowance)
- £12,571 – £50,270: 8.75% (Basic Rate)
- £50,271 – £150,000: 33.75% (Higher Rate)
- Over £150,000: 39.35% (Additional Rate)
In addition, you will not pay any tax on the first £2,000 that you are paid in dividends.
Pros and cons of using company dividends to pay yourself:
|More tax efficient than receiving your pay through PAYE.
|Cannot be used if not making a profit.
|No requirement to run payroll or send RTI information to HMRC (and no risk of a fine if you do not submit the RFT information on time).
|Requires some company administration to issue, including board meetings and dividend vouchers (see below).
|Greater flexibility as to when you draw money to pay yourself.
|Corporation tax is paid on profits before dividends are paid out.
How to pay yourself a dividend
To pay yourself a dividend as a company owner/director, you will need to ensure that the following steps are followed:
- Check that the company has enough profit on which you can pay yourself dividends. This will be shown on your most recent balance sheet and profit and loss account.
- Hold a directors’ meeting to “declare” the dividend that you intend to pay yourself.
- Keep minutes of the meeting (this must be done even if you are the only company director).
- Generate a dividend/tax voucher for each shareholder showing the date, company name, names of the shareholders who will receive a dividend and the amount of the dividend. A copy of these should be kept for your company records.
- Issue the approved dividend payments and dividend vouchers.
- File the board minutes at your registered office.
How much dividend can I pay myself?
There is no set limit to how much dividend you can pay yourself. This will depend upon how much profit you are making (remember that you can only pay dividends on your profits). It is also important to bear in mind that the more dividend you pay yourself, the more dividend tax you will pay, especially as you pass through each of the thresholds above. This is why some business owners leave profits in the company, since they can then draw down profits in the form of capital at a rate of just 10% when they sell their shares or close the company.
Option 3) Salary and dividends
By far, the most common option for small company owners is to pay themselves through a combination of the two methods above, i.e. receive some income through PAYE salary and some through dividends. It is important to seek advice from an accountant who can help you to decide whether this is the better option for your needs and how best to split the salary and dividend. By doing this correctly you can enjoy the benefits of both methods, the main one being that you can avoid the need to pay income tax and National insurance (NI).
Pros and cons of paying yourself a salary and company dividends:
|You can avoid the need to pay income tax and National insurance (NI) if you keep your salary below the NI threshold.
|You will still need to pay PAYE tax, run payroll and submit RTI information.
|You can continue to build your state pension without paying national insurance.
|You will need to complete the necessary administration and paperwork to prove that the dividend payments are legal.
|You can draw down money as and when you need it.
Whether you choose to pay yourself by way of a salary, dividends or a mixture of the two is very much a decision that must be made based on your exact circumstances. This will depend on factors such as when you begin to make a profit, the level of profit, whether you are paying PAYE tax through employment with another company and how much you plan to leave invested in the business. It is essential that you seek expert financial advice from your accountant or another specialist who can help you determine the best method of payment for you.
Uniwide Formations is a leading professional business service provider based in the UK. We can handle all aspects of your limited company or LLP registration and formation on your behalf. If you have any concerns regarding company formation documents or your Companies House reporting and filing obligations, then you are most welcome to contact our experts.