If you operate a limited company then you will need to decide on how you take out your income. Unlike a sole trader or partnership, a limited company is a separate legal entity and, as such, certain processes must be undertaken in order to ensure the salary payments are legitimate.
There are three main ways to withdraw money from the company: wages, expenses and dividends.
Wages are regular PAYE earnings like you would receive if you were employed by an employer. Wages are treated in a similar fashion and must be declared to HMRC on an annual basis (soon to be monthly). PAYE can be deducted from wages and it is important to know when and when not to take wages to ensure tax is not overpaid.
When to pay a wage: if you have no other additional income using up your personal allowance you will be able to utilise your tax free allowance through the company.
When not to pay a wage: If you have an additional paid employment or other sources of taxable income then it may not be wise to pay a salary from the company.
In some cases the best wage structure is to pay a small monthly wage that mirrors the monthly tax free allowance. By doing so enables a NI record to be created each year (and hence contribute to a state pension) and ensures that you pay the minimum amount of tax and national insurance. However, in some circumstances paying a minimum monthly wage is not appropriate or not allowed (IR35) and in these circumstances further advice is recommend.
Wages are declared each April/May and submitted to HMRC via P35 / P14 forms. From 2013 PAYE is to be declared monthly and thus the reporting requirements increase.
Although not classed as earnings (to declare on your tax return) paying back expenses is a tax free, efficient way of paying yourself from the company. If you pay for an item privately on behalf of the company then you will be eligible to reclaim these via an expense claim.
It is recommended to claim back expenses each month and these can include business miles travelled, any item of expenditure paid personally or a "use of your home" allowance.
However, it is important to keep any receipt that you are claiming back from the company.
A dividend is paid from distributable profits from the company. Distributable profits are those profits earned cumulatively over 1 or many years and calculated after corporation tax has been taken into account or paid.
A dividend is not a company expense and thus does not reduce the profit of the company. However, a dividend paid to an individual in the basic tax bracket is essentially tax free and payments can be made up to the higher tax bracket before they become taxable.
A dividend is a great way to take money out of the company as the tax is paid from the company profits, currently at 20%. However, if taking all as wages there is not only tax (at 20%) but also National Insurance paid by the employee (12%) and employer (12.8%).
Certain conditions must be met in order to pay a dividend - such as profits in the business or being a shareholder. There is also a requirement to officially declare a dividend and be able to provide dividend tax vouchers if required.
The above methods are recommended for UK resident directors and shareholders. If you are non resident then certain payments may not be recommended and it is important to take further advice.