Business owners work hard for every penny they earn, so you’d think taking a strategic approach to optimising their own remuneration would be top of their ‘to do’ list. Not always – we frequently come across directors of limited companies who are simply taking money out of their company on an ad hoc basis, expecting their accountant to allocate it at the year-end as a loan, dividend or salary. Because they haven’t planned a structured payroll strategy, they are a) paying more tax than they need to and b) risking getting themselves into a tangle with HMRC.
If this sounds like you, you need to focus on structuring your remuneration in a planned way – implementing payroll on a regular basis to utilise your personal tax free allowance, and structuring your dividends so you know you’ve correctly attributed dividend income on top of salary.
Having a payroll strategy will make sure that you:
HMRC are on the look-out for businesses making retrospective calculations. Naturally, they’d like to be able to consider all money you take from your company as a salary, charging tax and NI, and if you don’t have a strategy in place, you leave yourself exposed to being challenged.
If someone offered you £10k, tax free with no strings, you’d snap it up wouldn’t you? Well contrary to popular belief, HMRC don’t just take – they also give, and every one of us is entitled to an annual tax free allowance – an amount of money we can earn before we are liable to pay income tax: For the tax year 2014/15, the allowance is £10k for most people, and this figure rises to £10.6k for the new tax year beginning on April 6th 2015. But your personal tax allowance works on the principle of ‘use it or lose it’, which means if you are an owner / director of a limited company, you need to plan how you pay yourself in order you make use of your full allowance.
If you’re the owner of a limited company, you’ll know that dividends are a tax efficient way of remunerating yourself, but because they’re paid from a company after corporation tax has been deducted, and because no tax-free allowance applies to corporation tax – as soon as you start to make profit, you’ll start to pay tax. This means that if you wanted to earn your tax-free annual allowance of £10k and pay yourself through dividends, your company will have to make £12.5k profit in order to pay you £10k in dividends. If instead you were to use a payroll mechanism and pay yourself a salary, because it’s tax deductible to the company, paying you £10k salary could cost the company as little as £10k (exactly how much depends on how many people you employ and the annual employment allowance).
In summary then, by paying a salary for your tax-free allowance rather than a dividend, you will save up to £2.5k in corporation tax - per director owner, per year – because instead of having to make a £12.5k profit to pay a £10k dividend, you now only need to make a £10k profit to pay a £10k salary!
Of course, this might well be the case if you’re a new start up, but your personal tax free allowance can’t be carried forward from one tax year to another. You can still set up your payroll in the current year though – in the expectation that the business will make a profit in future tax years. The way you’d operate this would be to lend your company money to pay yourself your salary – and the company will repay this loan to you as soon as there are sufficient funds in the business. Funds lent by directors to their company are generally lent and repaid tax free , so you’re not storing up a future tax liability, you’re actually generating a future tax saving! If you want to do this though, you have to action it before the end of the tax year.
Actioning payroll planning is especially important if you’ve set up your limited company during the 2014/15 tax year. If you came out of employment and had already earned at least £10k prior to leaving, you’ll already have used up your personal allowance, so there will be no benefit in setting up payroll in the 2014/15 tax year, but getting your strategy in place now will mean you’re ready to take advantage of your new tax allowance which kicks in on 6th April – and make sure you’re earnings are as tax efficient as possible for the remainder of your first business year.
Many sole traders aren’t aware that they can employ people – and that this can present an opportunity to save tax. If you’re a sole trader and your spouse or life partner helps you out in the business but doesn’t get paid and has no other employment, their personal tax allowance is going to waste. By employing them and paying them through a payroll system, you can keep the tax allowance within the household, and remunerate them for their work.
If you’re a company director without a payroll strategy, if you’ve set up a limited company within the last 12 months, or if you’re a sole trader with a spouse or partner doing unpaid work for you, we’d love to speak with you and tell you how we can plan, set up and manage your payroll – and save you money!
We’ve prepared a simple guide to help you decide if payroll would benefit you and your business. Call us on 01235 868 888 or email us now firstname.lastname@example.org to obtain your FREE copy!
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