Tips on extracting income from family companies.

Tips on extracting income from family companies.

Many of our clients run family businesses and they often ask for our advice on the most tax-efficient way to extract funds from the business. There are a number of factors that need to be considered such as:

Bonus v dividend

The main profit extraction debate centres on whether it is more efficient to draw a salary or to pay a dividend. Each has its merits.

From the company perspective, money paid by way of a bonus or salary is deductible for corporation tax purposes. However, the company, as employer, is also liable to pay employer’s NICs (13.8%). The bonus or salary is taxable in the hands of the recipient under PAYE and primary Class 1 NICs are also payable.

Dividends, meanwhile, are paid out of retained profits and as such they are not deductible for corporation tax purposes. However, there is no National Insurance to pay on dividends. Further, there is no additional tax to pay when received by a basic rate taxpayer. The effective tax rate for higher and additional rate taxpayers, after taking into account the 10% tax credit, is 25% and 36.11% respectively. When paying dividends it is important that the company has sufficient distributable profits and dividends are properly declared in accordance with company law requirements.

To maintain your benefit and state pension entitlement, our advice is to pay a small salary between the lower earnings limit and secondary threshold for NIC purposes (this is between £102 and £136 per week for 2011/12).

Impact of tax rates

Falling corporation tax rates and rising National Insurance rates, swing the pendulum in favour of dividends. From April 2011, the combined rate of employer and main rate employee NICs (12% + 13.8%) is higher than the small profits rate of corporation tax (20%), meaning that the NIC savings associated with a dividend outweigh the loss of corporation tax relief. However, there is no substitute for conducting a thorough assessment before taking action, as this is the only way to reflect all aspects of an individual’s personal circumstances.

Capital v income

Options for extracting profits in the form of capital may be limited, with capital gains tax rates currently at lower levels than income tax rates. However combined with the availability of the capital gains tax annual exemption, where the opportunity to withdraw capital is available, this is likely to be an attractive option from a tax perspective.

If you’d like advice on the best way to extract profits from your business why not give me a call and let me advise you based on your circumstances.

You can also get more advice by following @bevanbuckland on twitter or registering for our newsletter at www.bevanbuckland.co.uk

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