As a director of a UK limited company, one of the key decisions you need to make is how to pay yourself. While dividends can be an attractive option, paying yourself a salary through payroll—especially up to your personal allowance—can be a smart way to save on corporation tax. In this article, we’ll explore how this works, provide a worked example to illustrate the benefits, and guide you through the steps to set up payroll for your limited company.
Understanding the Personal Allowance
The personal allowance is the amount of income you can earn each tax year before you start paying income tax. For the tax year 2024/25, the personal allowance is £12,570. By paying yourself up to this threshold, you can avoid income tax on that portion of your earnings. But there's another advantage: it can reduce your company's corporation tax liability.
How Paying Yourself a Salary Reduces Corporation Tax
Corporation tax is levied on a company’s profits. By paying yourself a salary, the amount paid is considered an allowable business expense, which reduces the company’s taxable profits. Let’s look at a worked example to see how this benefits your company, including the impact of National Insurance Contributions (NICs) when the Employment Allowance is not available.
Worked Example: The Tax Savings of Paying a Salary
Imagine your limited company has profits of £50,000 before any salary is paid to you.
No Salary Scenario:If you decide not to pay yourself a salary, the entire £50,000 would be subject to corporation tax. For the 2024/25 tax year, the corporation tax rate for profits up to £50,000 is 19%.
Corporation Tax = £50,000 × 19% = £9,500
Your company would have to pay £9,500 in corporation tax, leaving you with £40,500 of retained profits.
Salary Scenario with Employer NICs:Now, let’s assume you pay yourself a salary equal to the personal allowance of £12,570. This salary is a deductible business expense, reducing your company’s profits: Adjusted Profits = £50,000 − £12,570 = £37,430 Employer NICs Calculation: Employer NICs are payable on salary amounts above £9,100 at a rate of 13.8%. So, the NICs due on your salary would be: Employer NICs = (£12,570−£9,100) × 13.8% = £3,470 × 13.8% = £478.86 This NIC amount is also an allowable expense, further reducing the company’s profits: Final Adjusted Profits = £37,430 − £478.86 = £36,951.14 Now, your company pays corporation tax on £36,951.14: Corporation Tax = £36,951.14 × 19% = £7,020.72 Your company’s tax bill is now £7,020.72, a saving of £2,479.28 compared to the no-salary scenario. Total Cost to the Company: The total cost to the company for paying your salary, including NICs, is the salary plus the employer NICs: Total Cost = £12,570 + £478.86 = £13,048.86 Overall Tax Savings: The total tax saving from paying the salary and NICs is: Savings = £9,500 − £7,020.72 = £2,479.28
Income Tax and National Insurance Considerations
In this scenario, the salary of £12,570 falls within your personal allowance, so you won’t pay any income tax on it. Additionally, with the employee NIC threshold for 2024/25 being £12,570, you won’t pay any employee NICs on this salary either.
However, since your salary exceeds the secondary threshold for employer NICs (£9,100), your company will still be liable for employer NICs on the portion above £9,100, as calculated earlier.
Given these thresholds, the salary within the personal allowance is still tax-efficient, even though the absence of the Employment Allowance means that you must account for employer NICs.
How to Set Up Payroll for Your Limited Company
To take advantage of this tax-saving strategy, you’ll need to set up a payroll system for your limited company. Here’s how:
Register as an Employer with HMRC:First, you’ll need to register your limited company as an employer with HMRC. This can be done online through the HMRC website. Once registered, you’ll receive an employer PAYE reference number and an Accounts Office reference number.
Choose Payroll Software:You’ll need software to run your payroll. Many options are available, including HMRC’s free Basic PAYE Tools or other commercial software that can handle more complex payroll needs.
Report to HMRC:Every time you run payroll, you’ll need to report the pay and deductions to HMRC. This is done via Full Payment Submission (FPS), which your payroll software should handle automatically.
Paying Your Salary:Set up a regular payment to yourself through your company’s bank account. Ensure that this is in line with your payroll calculations, and keep detailed records of all payments.
Paying PAYE and NICs:If you owe PAYE or NICs, these must be paid to HMRC, typically on a monthly basis.
Conclusion
By paying yourself a salary up to the personal allowance, you not only avoid paying income tax and employee NICs but also reduce your company’s corporation tax liability. However, it's crucial to consider the cost of employer NICs, especially if your company does not qualify for the Employment Allowance. Even with this cost, the overall tax savings can make this strategy worthwhile. Setting up payroll may seem daunting, but with the right software and a clear understanding of your responsibilities, it can be a straightforward process that pays off in the long run.