Maximising profit extraction from your business
If you own a limited company, effective profit extraction is crucial for your personal financial health.
There are several strategies to optimise your post-tax profits, including a salary, dividends, and a director’s loan.
Understanding your limited company
A limited company is legally separate from your personal finances, offering both advantages and disadvantages for profit extraction.
Advantages
- You are personally protected from liabilities related to tax and debts incurred by your business.
Disadvantages
- Profits belong to the company rather than to you personally.
Profit extraction is a significant factor in deciding whether to incorporate your business or operate as a sole trader or partnership.
Strategies for profit extraction
Paying a salary
As a company director, you are typically classified as an employee of the business and are entitled to be paid a salary through the payroll.
The salary amount can be any value, provided all operational and staffing costs are covered. However, you might choose to take a lower salary up to the value of £12,570 (the current Personal Allowance).
A lower salary, used alongside other extraction methods, can be a tax-efficient way of receiving profit from your company.
Dividends
If your business is making a profit, some of this can be distributed to yourself, as a director, alongside other shareholders.
It’s important to note that dividends have become less tax-efficient in recent years due to the tax-free Dividend Allowance decreasing from £5,000 in 2017/18 to £500 in 2024/25.
However, paying yourself a lower salary may allow you to benefit from a lower rate of Income Tax on your dividends compared to earning a higher salary.
Dividend tax rates:
- Basic rate: 8.75 per cent
- Higher rate: 33.75 per cent
- Additional rate: 39.35 per cent
Director’s loans
Director’s loans allow you to extract profits from your business without creating an immediate tax liability. The usual timeframe for the loan to be repaid is within nine months of the end of your business’s accounting period.
Tax considerations:
- Income Tax: Generally not paid on director’s loans, though you must report a 'written off' (non-repayable) loan by Self-Assessment.
- National Insurance: Written-off loans or loans of £10,000 or more are classed as benefits in kind, Class 1 National Insurance Contributions are due.
- Corporation Tax: Loans made to a director of a close company with a material interest in the business exceeding £15,000 may be subject to Corporation Tax, which is refundable upon repayment of the loan.
Use director’s loans carefully to avoid disrupting your business’s cash flow or creating personal debts you cannot manage.
Getting the balance right between these profit extraction methods is challenging, which makes seeking advice from a tax advisor essential.
Please get in touch with the team at Iceberg Accounting for advice on salary, dividends, and director’s loans.