When you set up a Limited Company and start to make money, it’s not long before you begin thinking about how you reward yourself with some of the hard-earned profits.
But simply ‘paying’ yourself and treating your business bank account as a personal account is a common mistake new business owners make.
Your business is a separate legal entity – you are a director and also an employee of it. This has plenty of advantages but means taking money out of a Limited Company must be done using methods such as a salary or dividends.
How to Take Money Out of a Limited Company
Extracting money from a Limited Company is not the same as if you were a sole trader when you could simply withdraw cash from the bank account when you wish. Instead, the money in your business bank account belongs to the business. Therefore, the assets and profits legally belong to the company – not the owners or shareholders.
As your business makes a profit, this can feel like money is ‘stuck’ in your account, with you unable to take it out.
Feeling confused? Don’t worry – there are several legal ways for you to quickly and consistently access the money in your business, so long as you follow the correct procedure:
- Paying Out Dividends
- Paying a Director’s Salary with PAYE
- Using Directors’ Loans
- Reimbursement of Your Expenses
1. Paying Out Dividends
Dividends are a common, tax-efficient way for business owners to pay themselves when their company makes a profit.
Dividends can be paid in bulk at the end of a financial year or consistently throughout the year. Many owners of Limited Companies choose to pay the bulk of their earnings in this way because of the tax benefits.
When your company makes a profit, it will need to pay Corporation Tax on that profit at the end of the financial year. Corporation Tax is currently charged at 19% of profits, though that’s due to rise to 25% on profits over £250,000 in 2023.
After Corporation Tax, with what’s left, you have two main options – reinvest the profits or pay a dividend to shareholders.
Shareholders might mean just you, or you and a business partner who is also a director. Either way, dividends from these profits can be paid to directors. Dividends paid regularly throughout the year are known as interim dividends and can be used to supply directors with a regular, relatively low-taxed income.
Directors are given an individual tax-free allowance of £2,000 each financial year. This literally means your Limited Company can pay you £2,000 without you being personally taxed on this amount each year, so it’s well worth taking advantage of.
After that, dividend payments are subject to the following tax rates:
- 8.75% for basic rate taxpayers
- 33.75% for higher rate taxpayers
- 39.35% for additional rate taxpayers
To work out your tax band, you’ll need to add up your total income and check which Income Tax band you fall into. Check the Government website to see which band you fall into.
You should be wary of paying dividends if your business is likely to make a loss. If you’re not profitable and continue to pay yourself this way, you’ll be paying illegal dividends and could be subject to action by HMRC.
There’s one final process you should be aware of when paying dividends. You must declare the total dividend you will pay at a board meeting and record this, even if you’re the only director or shareholder.
2. Paying a Director’s Salary with PAYE
Paying yourself a salary from a Limited Company with Pay As You Earn (PAYE) is the other common way of extracting money from a business.
This involves registering with the PAYE service and paying yourself as an employee along with the rest of your staff if you have employees.
The key here is how much you pay yourself, as limiting your salary will mean you pay less in Income Tax via PAYE. It’s common for directors to then top up their earnings with dividend payments.
One common tactic is to pay yourself a salary just at the limit of the personal tax allowance – currently at £12,750 in 2022. This is the salary you can earn without paying tax. Then you can pay yourself dividends after this, at a lower rate than paying income tax on your salary over £12,750.
When paying a salary, you (or your accountant) will need to deduct any Income Tax and National Insurance contributions and report this alongside Employer contributions on a monthly or quarterly basis to HMRC.
3. Using Directors’ Loans
Directors’ Loans can be paid from a Limited Company to a director or by a director to a company – the loan can go both ways.
In a young company, a director might pay a company a loan to invest in its growth, and then the company would pay it back.
But Director’s Loans can also be used as a way to extract money from a business. You should be cautious, though – a Director’s Loan is ultimately still a loan that needs to be repaid, so it’s not a long-term way for a business to pay you.
If you borrow money from your company, no tax will be payable on what’s known as your Directors Loan account if the money is paid back within nine months and one day of the company’s year-end. If you choose for the company to write off the loan, you’ll need to pay the relevant income tax on it in your Self Assessment Tax Return.
If you want to use Directors’ Loans to get money out of a business, it’s well worth taking professional advice. In addition, all loan transactions should be recorded on the company’s Balance Sheet.
4. Reimbursement of Your Expenses
There are two main ways of paying company expenses – the company could pay for expenses related to the running of the company directly from a business bank account, or you can pay them from your personal account, and the company reimburses you.
It’s not uncommon for directors or business owners to rack up expenses in the day-to-day unwittingly, particularly mileage expenses for business travel.
These expenses should be recorded each month and repaid as part of your salary. They are not subject to tax – PAYE or otherwise – like your salary.
Can You Take Money Out of a Company Without Paying Tax?
Practically, the short answer is no. There is no way of taking money out of a Limited Company for the purposes of paying yourself and escaping tax.
As detailed above, you could take a loan from the company, but Directors’ Loans must be paid back, or you will face having to declare the sum as income and pay the appropriate tax as part of your Self Assessment Tax Return.
The only other legal method of extracting money from the company is reimbursement of expenses – but this is essentially only paying yourself cash with which you’ve already parted ways.
In essence, rather than paying no tax at all, directors are generally advised to find the most tax-efficient method of paying themselves – usually through a combination of salary and dividends.
What is a Cash Mountain in a Limited Company?
A Cash Mountain is the term for a large build-up of cash that sits in a company’s bank account. It often occurs because the company’s owners or directors would rather not pay tax on the dividends required to withdraw it.
While having cash at your disposal is sometimes considered a good thing, particularly for reinvesting in the company, there’s the obvious disadvantage of cash building up for no real purpose if it’s not going to be spent on growing the company.
Paying large sums of money from your company’s ‘Cash Mountain’ to yourself is likely to push you to a higher rate of tax on dividends, which would not be desirable.
One option is to pay it as pension contributions. Putting money into a pension has the added benefit of qualifying for Corporation Tax relief while also helping you effectively save for retirement.
You could also consider investing the money – a company could invest in property, for example, and earn a return on investment over time. The downside to this approach is that it could affect the company’s trading status for claiming Entrepreneurs Relief.
How to Take Money Out of a Limited Company When You Close It
When you close a Limited Company, any remaining money is usually paid to shareholders as a dividend and tax paid on that dividend.
An alternate method is potentially paying less tax if your company has cash reserves of more than £35,000 – a Members Voluntary Liquidation or MVL.
If you qualify for an MVL, the reserves are distributed as capital instead, which is subject to Capital Gains Tax. However, if you also qualify for Entrepreneurs Relief (also known as Business Asset Disposal Relief), you’ll have the added benefit of this tax rate potentially being reduced.
It is worth bearing in mind that this method is strictly not meant for tax avoidance, and you should ensure you don’t intend to run another Limited Company after closing one.
If you feel like your money is ‘stuck’ in your Limited Company, you’re not alone – many owners feel apprehensive about extracting money from the business and having to pay tax as a result.
Ultimately, though, there is no way of escaping this outcome – and building a cash mountain has little in the way of practical benefit.
Instead, focus on paying yourself through a tax-efficient combination of salary and dividends – utilising Directors Loans when required and ensuring the business regularly reimburses your expenses, particularly mileage.
If you need advice on the best way to do this, the Future Strategy team can help you create the most effective plan to ensure your business pays you regularly.