The pandemic has made our lives difference with some business owners having been disadvantages as they used dividends as a profit extraction. The article will shed some light on how to extract profits from your company most efficiently and avoid being disadvantaged in future.
Profit extraction and tax efficiency
To maximise tax efficiency a director can pay themselves a minimum salary up to the NI secondary threshold (£8,840.00 per year). The rest of the pay can be topped up by dividends. However, dividends can only be paid out of company’s profits.
Trap: No profits mean no dividends. Thus, when the company is not making profit, the director can either pay more salary which means more tax and NI or borrow from the company. The director’s loan can also be less tax efficient and will depend on how they are going to repay the debt.
Maximising Dividends Payments
In certain times, it can be more tax efficient to pay dividends even if there is no immediate need for cash.
Example 1: Vickie and Jane started a company in 2017. Their accumulated company’s profits by the end of 2019 financial year were £170,000. They paid themselves dividends of £110,00 in addition to their salary. Later of their business has suffered due coronavirus and in the next year, their remaining profit was offset by an enormous loss. Vickie and Jane do not project their business to return to their overall profit until 2023. The loss in the consecutive financial year prohibits them to pay dividends. this situation leaves them with less tax efficient option to pay themselves salary as an alternative.
Example 2: in the situation above, it would have been more tax efficient to pay out £170,000 all the profit they generated as dividends before the financial hit. At the time when Vickie and Jane did not need all the money, they could leave some on their loan account and draw it later without tax or NI.
Tip: Taking dividends sooner from the income will mean more tax and NI efficiency compared to the situations when the directors allow losses erode the remaining profit.
Conclusion
In the situations of uncertainty over the future profits, it would be advantageous to draw all the net profits as dividends. If you do not need all the cash, it can be left in the company’s load account.
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