There are a number of different ways to devise a tax-efficient method of extracting profits from a small business. The best way to do this for each business may vary so it is always worth talking to a professional accountant for the best advice. However, the points outlined you should try starting a limited company below are generally useful methods for most small businesses to save tax.
Taking Profits out of a Limited Company
If an employee’s salary is between the lower earnings limit for Class 1 National Insurance Contributions (NICs) and the primary earnings threshold they are considered to have paid NIC at zero per cent. Therefore, if a small business pays the directors or employees a salary within these boundaries they effectively maintain NI contributions and, hence, entitlement to a state pension without it actually costing them anything.
So by extracting profits from a small business mainly through dividends National Insurance contributions for both employer and employee can be avoided without losing any benefits.
A salary that is not liable for NICs is also below the income tax threshold although employers must still report the salary information to HMRC.
If the company only has one employee/director or no employees who are paid above the secondary threshold consideration should be given to setting the right level of salary to take advantage of the Employment Allowance that Employers are able to claim, which can minimise the amount of employers NIC that the company is liable for.
The Employment Allowance is available where a small salary is being paid to preserve pension entitlements but NI is charged at zero per cent, as described above.
Be aware that it is sometimes beneficial in a one-man company to pay the 12% NICs in order to save some corporation tax at 20%.
A typical strategy for small businesses to save NIC and income tax is to pay directors a salary above the lower earnings limit (LEL) and below the secondary threshold for NI. This maintains entitlement to the state pension at no cost but also keeps the salary below the level when income tax becomes due.