People go into business for a wide variety of reasons, but the main one is usually to make money. Profit is often the number one goal, and it takes a lot of hard work, dedication and sleepless nights to achieve. After all of the time and money that you have put into the business, it is only natural to want to reap some of the rewards too, so how do you go about extracting profits from your business?
Profit extraction comes in different forms, from salaries and bonuses to dividends and pensions so it is important to work out which one is best for you and how to be tax efficient in your decisions in order to fully make the most of the profits that you have been working so hard to earn.
Everyone in your business should get paid, but in small businesses, it is often the business owner who gets paid the least, if anything at all. To start with, some business owners refuse to take money out of the business while it gets on its feet, but later it comes down to the fact that this is not always the best way to release your profits. This is often because income tax, national insurance contributions and employee contributions will need to be paid on a salary of over £12,570. You will then pay 20% on earnings up to £37,700 and 40% on earnings between that and £150,000.
Also, if you have other sources of income, such as rental income or savings interest, this will also count towards your personal allowance and the amount you can then pay yourself without tax is even less. Whilst this approach does save you money in one sense, the recent furlough scheme has highlighted the fact that it is flawed when it comes to claiming government assistance. As the scheme was only based on salary and not bonuses or dividends, many business owners found themselves severely short-changed having not declared much of an income previously.
Dividends are a popular way for may business owners to extract profits alongside their salary. Once salaries and all other business expenses have been deducted, what is left is profit that can be distributed to shareholders. Each individual can claim a £2000 annual dividend allowance tax free, and anything above that is taxable at various rates.
This can be an efficient way to pay yourself as you only get paid when the money is in the company to do so, whereas salaries are paid regardless of profits. Dividends are added on top of other income, so it is important to remember that this may move you into a different tax band and the associated tax rate.
Some business owners choose to pay into a pension instead of their bank account as these payments are deductible against corporation tax. Company directors also benefit from tax relief on pension contributions of up to 100% earnings or a £40,000 annual allowance depending on which is lower. Anything over this is subject to income tax but at a more favourable rate than salary payments.
Obviously, this is also a good way to save for your retirement as well, meaning that this option has far reaching benefits.
The are a variety of ways to extract profits from your business, but it is important to spend some time researching which is best for you and your business before deciding on one. This will mean you can do it in the most beneficial way and finally get the rewards for all of your blood, sweat and tears.
Rogers Spencer are Chartered Accountants in Nottingham who can provide businesses with tailored accountancy services, which includes Bookkeeping, Business Taxation, Private Client Taxation, Audit & Assurance and more.