For many small sports or fitness business the directors tend to be both a director and shareholder, so they both own the company as a shareholder and run it as a director. And unlike a sole trader, a limited company director/shareholder cannot simply withdraw money from the business.
This means limited company directors can get paid in two ways – through a salary and in dividends. We discuss each below as well as the options for combining both.
Personal Allowance
Before we get into dividends and salaries it is worth mentioning the personal allowance.
All individuals have a personal tax-free allowance of £12,570 (23/24 tax year) meaning any income under this amount, whether it comes from salary or dividends, is tax-free. For every £2 earned over £100,000 the personal allowance is reduced by £1, so if you earn £125,140 or over your personal allowance is reduced to zero.
Paying limited company directors through salary
Just as employees, directors are able to receive a salary from their company. This is processed through the PAYE system where any tax and national insurance contributions are taken before the salary is paid to the individual, the company then passes this on to HMRC.
Company considerations
The company will need to register with HMRC for PAYE and pay Employer National Insurance Contributions (NIC). Employer NIC is 13.8% on any salaries above £9,100 a year (23/24 tax year), which is known as the secondary threshold.
Companies may be eligible to claim the employment allowance allowing them to reduce the employer national insurance up to £5,000 a year. However, companies with only one employee who is also a director of the company cannot claim this.
Salaries and wages are allowable expenses meaning the company can take them into account in order to lower the company’s corporation tax bill.
Individual considerations
Salaried employees and directors will pay tax on their income. For the 23/24 tax year, any income received above your personal allowance of £12,570 is taxed at the following rates.
Basic rate: 20% on taxable income up to £50,270
Higher rate: 40% on taxable income between £50,271-£125,140
Additional rate: 45% on taxable income above £125,140
Salaried employees and directors also pay national insurance (NI). Each employee pays 12% employee NI on any salary income over the primary threshold, £12,570 a year (23/24 tax year), and 2% for a salary over the upper limit, 50,270 a year.
Something else to be aware of is the lower earnings limit which for the 23/24 tax year is £6,396. Taking a salary above the lower earnings limit classes as a qualifying year towards your state pension.
Paying limited company directors through dividends
A dividend is a payment to the shareholders of a company from the profits. Limited companies may issue interim dividends (at intervals during the financial year) or final dividends at the end of the financial year. These must be declared and approved at board meetings. Provided a director is a shareholder they can also be paid through dividends.
Company considerations
Unlike salaries, dividends are paid after corporation tax has been deducted so they do not lower the company tax bill. Also, dividends can only be declared from company profit. If the company makes a loss then no dividends can be declared.
Individual considerations
The first £1,000 (23/24) of dividends received by a company director is tax-free due to the dividend allowance. This is in addition to the personal allowance discussed above.
For any dividends received above that figure tax will apply. Dividends will be taken into account after salary and the following tax rates apply for the 23/24 tax year;
· Basic rate: 8.75% up to £50,270
· Higher rate: 33.75% between £50,271 – £125,140
· Additional rate: 39.35% above £125,140
Combination options for limited company directors
As we mentioned at the start of this article, most limited company directors get paid through a combination of salary and dividends. We will discuss below a few scenarios to help you choose the best option for your fitness business.
Taking a salary of £9,100 – a simple solution for sole directors
For sole directors with no employees, a common approach is to take a salary above the lower earnings limit of £6,396 (23/24 tax year) to class as a qualifying year for state pension but not above the secondary threshold at £9,100 to avoid paying employer national insurance.
This is also below the personal allowance of £12,570 making it tax-free plus the salary is allowable for corporation tax which can lower the company tax bill.
Admittedly this isn’t as tax efficient as the below option by approx. £200 but it does reduce the admin and cashflow headache of paying PAYE each quarter, which in turn could result in fees higher than the saving if you pay someone else to handle this for you.
Taking a salary of £12,570 – optimum salary for many
If your company is eligible to claim employment allowance, the employer’s national insurance contribution of going above the secondary threshold of £9,100 can be claimed back.
With this in mind, you might be better off taking a higher salary of £12,570. This is below the personal allowance threshold, will count as a qualifying year for state pension, and will further reduce the company tax bill.
If you are eligible to claim employment allowance, you will already have the admin of paying PAYE anyway.
Complimenting salary with dividends or a bonus
From here generally, in the past years, the rest is taken in dividends, utilising the dividend allowance and the remainder of any available personal allowance, which is the most tax efficient.
Although this will still be true for many, due to the changes in corporation tax rates for the 23/24 tax year, this isn’t the most tax efficient for everyone. There are situations where topping up with a bonus – which would be treated for tax purposes the same way as salary – could be more tax efficient. This generally applies more to those individuals who
would pay tax at the additional rate and whose company’s corporation tax rate is higher 25% level. Although the gains tend to be marginal and potentially not worth the time and money to crunch the numbers.
Of course, the exact combination of salary and dividends will depend on your individual and fitness business circumstances. If you do not fit cleanly into one of the scenarios above is always worth talking to a bookkeeper or accountant to get a better idea of what is best for you.