Income from a Limited Company (LTD): What You Need to Know
Income from a Limited Company (LTD): What You Need to Know
Melissa Deacon
As a director or shareholder of a limited company, how you choose to take income from the business can significantly impact your tax liabilities. Whether you’re drawing a salary, dividends, or a combination of both, understanding the correct approach is essential for managing your finances efficiently and staying compliant with HMRC.
In this guide, we’ll explore the best practices, risks, and tax implications associated with taking income from your LTD company.
Do’s and Don’ts of Drawing Income from an LTD Company
Do’s
- Plan Your Income Mix Wisely
One of the key advantages of operating a limited company is the flexibility in how you take income. Most directors opt for a small salary and supplement it with dividends, which are taxed at a lower rate. Careful planning of this mix helps to minimise tax liabilities. - Use Tax-Efficient Benefits
Take advantage of tax-efficient benefits such as employer pension contributions, cycle-to-work schemes, or childcare vouchers. These benefits can reduce your tax burden while providing valuable perks. - Keep Accurate Records
Maintain detailed records, especially when dealing with dividends. Ensure that board minutes document dividend declarations, and keep a clear record of payments to avoid issues during an HMRC audit.
Don’ts
- Exceed Your Personal Allowance Unnecessarily
For the 2024/25 tax year, the personal allowance is £12,570. Keeping your salary within this threshold helps avoid unnecessary income tax. Dividends can then be taken in a tax-efficient manner on top of this. - Forget About National Insurance Contributions (NICs)
If your salary exceeds £12,570, you may need to pay NICs. Keeping your salary just above the threshold ensures qualification for state benefits while limiting your NICs liability. - Overdraw Your Director’s Loan Account
Taking more money from the company than you’ve put in can result in an overdrawn director’s loan account, which may trigger significant tax charges. Repay any loans within nine months of the company’s year-end to avoid these penalties.
Risks of Drawing Income from an LTD Company
1. Overdrawing Without Repayment
If you overdraw your director’s loan account and fail to repay it within the required time frame, your company will face a Section 455 tax charge of 32.5% on the outstanding balance. If the loan is later written off, it becomes taxable as income, leading to further tax liabilities and NICs.
2. Misclassifying Dividends as Salary
It’s crucial to correctly distinguish between salary and dividends. Misclassifying income can lead to backdated tax liabilities, penalties, and interest from HMRC.
3. Failing to Follow Proper Dividend Procedures
Dividends must be declared legally, with proper documentation and board meetings. If HMRC finds that dividends were not declared correctly, they may reclassify them as salary, resulting in higher tax liabilities and NICs.
Potential Implications with HMRC
HMRC Audits and Investigations
Improperly managing income, especially regarding dividends and director’s loans, can trigger an HMRC audit. This process can be time-consuming and stressful, with the possibility of backdated taxes, fines, and interest on any unpaid taxes.
Penalties for Incorrect Tax Returns
HMRC may impose penalties of up to 100% of unpaid tax if errors are found in your tax returns. To avoid this, ensure that all income is correctly reported and taxed.
Impact on the Company’s Financial Health
Mismanagement of funds, such as taking excessive dividends, can harm your company’s cash flow and financial health. This could leave the business unable to meet its obligations, leading to insolvency risks.
Practical Example: Income for an IT Consultancy
Imagine you operate an IT consultancy through a limited company. You decide to take a salary of £9,100—just under the employer’s NIC threshold—to avoid paying employer’s NICs but still qualify for state benefits. You also draw £30,000 in dividends.
Tax Implications:
- Salary: No employer’s NICs are due since your salary is within the threshold, and no income tax is due as it’s below the personal allowance.
- Dividends: The first £500 of dividends are tax-free due to the new dividend allowance for 2024/25. The remaining £29,500 is taxed at 8.75% (basic rate), resulting in a tax bill of £2,581.25.
Director’s Loan Account: If you take an additional £5,000 as a director’s loan, you must repay it within nine months of your company’s year-end to avoid a Section 455 tax charge. If not repaid, the company would face a £1,625 tax charge, and the loan would be treated as income, increasing your personal tax liability.
Risks: Failing to document the dividends properly could lead to HMRC reclassifying them as salary, resulting in higher taxes and NICs. Similarly, taking a loan without repayment could result in significant tax penalties for both you and your company.
Conclusion
Taking income from a limited company provides excellent tax planning opportunities, but it requires careful management to stay compliant with HMRC regulations. By following the dos and don’ts, understanding the risks, and being aware of the potential tax implications, you can optimise your income while minimising tax liabilities.
For personalised advice on how to structure your income from a limited company, contact Helpbox. Our team of experts can help you navigate the complexities and ensure your finances are optimised for success.