A freelancer or contractor working through their own personal service company needs to carefully plan how they draw out money from their company. You need to know the right mix and not get confused with salary or dividends. Discipline is needed with a limited company, so the director/shareholder can’t simply draw money informally when they want it. Money can only be drawn out one of four ways, each requiring the right supporting paperwork:-
1. Wage under the company’s PAYE payroll scheme, supported by payslips as notified to HM Revenue & Customs under their RTI (Real Time Initiative) system on each payroll date; and/or
2. Expenses reimbursements for where you have paid “out of pocket expenses” personally as supported by your expenses claims and receipts; and/or
3. Dividends out of “post tax” profits, as supported by a director’s meeting minute and dividend voucher; and/or
4. Director’s loan which may be subject to additional taxes.
Unless you are caught by IR35, the “optimum” situation will be:-
a – A monthly low wage of just above the NIC threshold, at which point no tax nor NIC is payable, but “credits” are earned towards state benefits;
b – Monthly reclaimation of your “out of pocket” expenses;
c – Withdrawal of any director’s loan account balance owing to you;
c – Quarterly dividends for the remainder of your needs, the limit being the amount of distributable “after-tax” reserves of the company.
Under the new rules, which came into force on 6/4/16, dividends are now subject to personal tax. There is a nil tax rate for the first £5,000 of dividends, 7.5% tax on dividends falling within the tax basic rate, and 32.5% tax on dividends above the higher rate threshold (and even higher if your total taxable income is over £150,000).
NB Of course, all the above figures change if you have other personal taxable income, such as pension income, investment income or other earnings from elsewhere, so you have to tailor your withdrawals accordingly.
Don’t forget if you are married or in a civil partnership, there are options to “spread” money between you in order to use your partner’s personal annual tax free allowance and basic rate band. You could appoint them as a director in order that the company can pay them a modest wage for their directorship role. You could “gift” some of your shares to them so that they can receive a share of the dividends paid by the company (again the first £5,000 of dividends being subject to 0% tax). If planned and implemented properly, you can effectively double the amount that can be drawn out of the company without breaching the higher rate tax thresholds and becoming liable to higher rate tax.
Contact us to discuss your options if you are thinking of starting a limited company or already have a company but want to change your withdrawals plan.