Most tax-efficient way to pay yourself

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Introduction   

As a contractor, when we consider how to be tax-efficient (UK), what should we contemplate? When you operate independently with your own company, there’s tax benefits available that aren’t there when you’re employed. Many will ask should I pay myself salary or dividends and this needs careful thought. When running your own business, you’ve the opportunity to take your income as a mixture of dividends and salary. Besides your overall contractor tax rate, an initial thought is what is the most tax efficient way to take money out of a company? Also, when running your own UK contracting business, what is the most tax-efficient way to pay yourself in 2023/24? These are common thoughts for many contractors. In summary, it’s key to consider limited company tax efficiency (UK), when considering your take-home pay 23/24.

Your income tax rate for contractors will vary, depending on your level of taxable income. In the UK, there is basic rate (BR), higher rate (HR) and an additional rate tax. When you’re a UK contractor, if you can achieve the most tax-efficient remuneration mixture of dividends and contractor salary 2023/24, it ensures your overall contractor’s tax rate is no higher than it needs to be. Therefore, we’ll look at tax rates for contractors and what is the most tax-efficient way to pay yourself and consider the options available. Furthermore, if you’re moving into contracting and want to see how much more tax advantageous this is, you could look online for a Contractor vs Employee salary calculator (UK).

Initial thoughts on the most tax-efficient way to pay yourself

How you can be tax-efficient and reduce contractor taxes 

As an individual, you may look to make the most of your personal savings. This could be in the form an account with a good interest rate. In a similar vein, you may look to make savings on your outgoings. Indeed, this could be by getting good deals for your household bills and lifestyle costs. Importantly, when you have your own company, you can choose what you pay yourself. As a result, there’s no reason why you should consider paying yourself tax efficiently and, as a result, reduce your contracting tax on the income that you take from your business.

When you run your own UK company, as a contracting professional you need to consider how do you pay yourself as a business owner (UK). When you’re a contractor paying yourself from a limited company, you should give this some thought. With your own contractor limited company, you have the option of paying yourself dividends. On the other hand, when you’re a sole trader or self-employed, this isn’t an option. Therefore, when it comes to paying yourself from your business (UK), it’s good that you have some flexibility.

Gain tax efficiency

When you’re contracting, it’s good to think about what you can do to gain tax efficiency (limited company and personally). Indeed, this’ll be by minimising your contractor rates of tax:

  • Make day-to-day savings through your business and, as part of this, maximise your company profit.
  • Find the best way to pay yourself as a director from your business. Indeed, you’ll aim to maximise your own take-home pay as a company director. As a result, you can pay yourself more. Therefore, owning your company enables you to take a mixture of dividends and salary. As a result, you can make use of the most tax effective way to pay yourself.

In this guide, we’ll look at the best way to pay yourself from small business. We’ll also look at how to become more tax-efficient. Indeed, this includes looking at limited company tax efficiency for high earners (UK). Also, as a limited company contractor, we’ll look at what to consider in terms of your UK contractor tax rate and tax efficiency in the 2023/24 tax year.

Make savings personally and as a business

When you’re looking to save money personally it’s good to reduce your spending. On the other hand, when you’re running a business, it’s good to reduce your tax bill:

  • As an individual, you could look to shop around in terms of what you buy. Secondly, you can put any of your savings into a Cash ISA or stocks and shares ISA. The ISA allowance 23/24 is £20,000, unchanged from 22/23.
  • As a business owner and limited company director, you can look for ways to improve tax efficiency (UK). Therefore, you can look to make savings on what your company buys. As part of this, it can look to make tax savings by claiming for all its valid tax-deductible business expenses. What’s more, when you claim for all valid expenses, it reduces the company’s tax liabilities. Indeed, if you claim all valid business costs, this helps to improve your overall contractor tax rate. Another way to save tax through your company is to ensure you pay yourself tax efficiently.

Further initial thoughts

In this guide, we’ll examine how to operate with limited company tax efficiency. We’ll look at the historic and current tax allowances, and the tax bands 23/24. This’ll also involve researching the UK tax and NI thresholds 23/24 and seeing how these interact with your income. What’s more, we’ll look at how to extract profits on a tax-efficient basis when running your own business. Further, we’ll research how to pay less tax as a limited company how to save tax as a contractor.

This guide has helped plenty of UK limited company contractors understand how to be tax-efficient. When you have a good contractor accountant, they’ll help to guide you here. One of our handy tax tips for UK contractors and small business owners is how to pay yourself tax efficiently.

Common questions on the most tax-efficient way to pay yourself

Those who work for themselves will likely have questions around tax-efficient ways to pay directors. Such questions could include:

  • How do you pay yourself as a limited company?
  • How much dividend can I pay myself tax-free?
  • What are the UK tax bands?
  • How to pay yourself from a limited company (UK)?
  • What is the basic rate of tax (UK)?
  • How to pay myself dividends?
  • Should I pay myself in dividends or salary?
  • How much is basic rate tax?
  • How to work out take-home pay?
  • What is the higher rate tax band?
  • How to reduce taxable income (UK)?
  • How to save tax in UK?

In this guide, we’ll cover the above in terms of tax efficiency and look at the UK tax bands history. We’ll also look at the current UK tax bands and how tax works in the UK.

Further initial thoughts 

The most tax-efficient way to pay yourself as a director

First, how to maximise your pay and operate as a tax-efficient limited company contractor isn’t always well understood. Therefore, we should consider how to pay yourself as a contractor. When we do this, it helps improve your overall contractor income tax rate.

Second, when an accountant takes on new clients, operating with tax efficiency is something that they don’t always fully understand. On many occasions, their previous accountant didn’t explain this to them very well. What’s more, the method to work this out isn’t too awkward if you’ve the correct information to hand.

In conclusion, once you’ve read this through, you should be aware of the following:

  • The best way to pay yourself tax efficiently via your UK limited company in 2023/24. This includes the tax-efficient ways to take money from a company.
  • How you can maximise your basic rate tax band 2023/24. When you know this, you’ll be aware of how much can I earn before paying higher rate tax.
  • How much should contractors save for taxes when they pay themselves from their companies. When we ask how to save tax as a contractor, you should always save your personal tax safely in a personal savings account. In due course, you can pay this to HMRC in due course, once it becomes payable.
  • How to be operate with tax efficiency when you run your own UK business. When you do this, it helps improve your contractor tax rate.

Financial year and tax year

The calendar year runs from 1 January to 31 December.

Your UK contracting company’s financial year starts from the first day of your accounting period. On the other hand, if it’s your first year, the start date will be your company’s incorporation. In both cases, the financial year will run to the date of your company’s year-end. Therefore, if your company was incorporated on 15 July 2023 and your year-end in future will be 31 July 2024:

  • The accounting period in year 1 will run from 15 July 2023 to 31 July 2024.
  • In year 2 it will run from 1 August 2024 to 31 July 2025.

The UK tax year runs from 6 April to 5 April. Therefore:

  • In the 2023/24 tax year, it will run from 6 April 2023 to 5 April 2024.
  • In the 2024/25 tax year, it will run from 6 April 2024 to 5 April 2025.

Tips and advice 

The most tax effective way to pay yourself as a contractor 

If you’re new to running your own company, there’s many things to consider. A good tip on how to reduce tax as a contractor is claiming all your genuine business expenses. As we mention earlier, this helps improve your contractor tax rate. This is because the tax your company and you pay, compared to the original contracting income that was earned, will be lower when you claim all valid expenses. It also helps if you claim all your costs each financial year, and they include:

  • Rechargeable expenses to your client.
  • Non-rechargeable expenses.

Expenses help to lower your company’s profit. This results in a lower Corporation Tax bill and more post-tax profits. More profits results in more funds available to you as dividends.

Salary payments are business expenses help reduce your company’s profit and tax. Therefore, from the outset, you should consider what your salary is going to be. Furthermore, you could also consider employing your spouse if they’re going to be helping you run your company.

Besides taking salary, you can also take tax-efficient dividends from your company. In turn, this helps decrease your contract tax rate in terms of tax efficiency. Therefore, when you have this choice, is it better to pay yourself a salary or dividends? In this guide, we’ll consider this however before we move on, there’s several aspects to regarding paying dividends. These include:

How to gain tax efficiency and improve your contractor tax rate 

One thing that does come up quite often from company directors is:

  • How I can operate with limited company tax efficiency.
  • What’s the best way to take money from a UK limited company?

To work the above out, first, you need to know:

  • What are the current tax bands (UK) and allowances?
  • How the above will interact with taxable income.
  • What are the current tax rates?
  • How the above is applied to different sources of income.

In summary, tax bands, allowances, and tax rates change over time. As a result, these all affect your contractor rate of tax. Therefore, to be able to operate and pay yourself with tax efficiency and improve your contractor tax rates, you need to know how your tax bands work and how your income is taxed each tax year. As a result, this’lll show you how much tax do I pay as a contractor.

Recent tax changes in the UK 

In this guide, we’re looking into how to pay yourself tax-efficiently and make the maximise use of your BR tax band. However, let’s look at some recent UK tax allowance changes.

First example

One recent change was some contractor tax changes 2016. Basically, this involved the complete overall of the UK dividend system. Before April 2016, the dividend that individuals received was 9/10ths of the gross. As part of this, they received a 10% tax credit. Dividends were taxed 0% in the basic rate tax band and 25% in the higher rate tax band. Also, they were taxed at 30.56% in the additional rates band. However, in April 2016, the government completely scrapped this. Instead, they brought in the tax-free dividend allowance of £5,000. Also, the higher rate tax band dividend increased to 32.5%. this was later increased to 33.75% in April 2022.

This £5,000 dividend allowance stayed in place for 2016/17 and 2017/18. In the next tax year in 2018/19, the government chose to reduce this allowance to £2,000. It stayed at this level until 2022/23. However, the dividend allowance 23/24 is now reduced to £1,000. In due course, it’ll reduce further to £500 in 2024/25.

Second example

A further example of a recent change is for bank interest income before April 2016. Prior to this, interest income was taxed at source (20%). However, after April 2016, you now receive interest tax-free but:

  • Basic rate band (20%) taxpayers can earn £1,000 interest per year with no tax. Therefore, this gives a maximum tax saving of £200 compared with the time before this.
  • Higher rate band (40%) taxpayers can earn £500 interest per year with no tax. Therefore, this gives a maximum tax saving of £200 compared with the time before this.
  • Additional rate band (45%) taxpayers can earn £0. I.e., they don’t receive a tax allowance for their interest.

A brief history of UK tax rates and bands 

First thoughts

The personal tax allowance and BR tax band usually change annually.

The personal tax allowance is the amount of income you can earn before you start paying income tax.

The BR band is the amount of income you can earn, on top of your personal allowance, that’ll be subject to the BR tax rate.

Most importantly, the standard personal allowance has been increasing over recent years. Meanwhile, the BR band has been increasing too. However, this wasn’t always the case, as is shown in the table in the next section. However:

  • In recent tax years in the UK, there are different allowances and tax rates in Scotland. Wales and Northern Ireland also have their tax allowances and tax rates, but these currently align with England.
  • In recent times, the government brought in separate rates and tax bands for savings. You should take these into account if you have sizeable savings.

The most tax-efficient way to pay yourself -historical personal allowances & tax rates 

Let’s now look at the historic UK tax brackets to see how they have changed over time. Therefore, the recent personal allowance and UK tax bands are as follows:

Personal allowance Basic rate tax Higher rate tax Additional rate tax
20% 40% 45%
2023/24 £12,570 £0 – £37,700 £37,701 – £125,140 £125,141
2022/23 £12,570 £0 – £37,700 £37,701 – £150,000 £150,001
2021/22 £12,570 £0 – £37,700 £37,701 – £150,000 £150,001
2020/21 £12,500 £0 – £37,500 £37,501 – £150,000 £150,001
2019/20 £12,500 £0 – £37,500 £37,501 – £150,000 £150,001
2018/19 £12,500 £0 – £34,500 £34,501 – £150,000 £150,001
2017/18 £11,850 £0 – £33,500 £33,501 – £150,000 £150,001
2016/17 £11,500 £0 – £32,000 £32,001 – £150,000 £150,001
2015/16 £11,000 £0 – £31,785 £31,786 – £150,000 £150,001
2014/15 £10,600 £0 – £31,865 £31,866 – £150,000 £150,001

Blind persons allowance

Under the UK tax rules, a blind person receives an extra tax allowance, and this is:

2021/22 £2,520
2022/23 £2,600
2023/24 £2,870

The most tax-efficient way to pay yourself -current allowances and future thoughts

In 2023/24, the total you can earn, which is the earnings limit before paying tax as a contractor, is your personal allowance of £12.570. The UK basic rate tax band is £37,700 and adding this to the personal allowance gives a total of £50,270. This amount is the income limit before you start paying tax under the higher rate tax bands.

As shown above, the income tax rates for the basic rate band of 20% and higher rate band of 40% have been consistent over recent previous tax years. These are the income tax rates which apply to earned income (salaries, self-employment profits etc.). The tax rates which apply to dividends are different because dividends come under the investment income category.

In the future, the personal tax allowance and BR tax band will carry on evolving. What’s more, when running your own business, it’s good to know what you can earn to make the maximum use of your BR tax band. As part of this, you’ll learn what tax you’ll need to pay in the future. In addition, we’ll look at how you can pay yourself tax efficiently and lower your overall contractor tax (UK).

The most tax-efficient way to pay yourself as a contractor -2023/24 tax year 

First considerations 

When you consider the most tax-effective way to take money out of a company, you could take the full £50,270 basic rate (UK) earnings in 2023/24 and stay within your BR band. However, your company needs to be earning enough profit to be able to pay you the £50,270.

As mentioned, the maximum an individual can earn in 2023/24 before paying higher rates tax is £50,270. There are, however, certain tax reliefs which can reduce your taxable income (this effectively means that your total income before any reliefs could be higher than £50,270), and these are namely:

  • Donations under Gift Aid.
  • Personal pension contributions.
  • Investments under Venture Capital Trust schemes (EIS, SEIS, and SITR).

If you earn £60,000 and have combined tax reliefs of £10,000, your taxable income will be £50,000. As a result, your total income will be in the BR tax band. Therefore, in this example, you could take £60,000 as income and still be in basic rate tax (UK).

To sum up, when you run your own business, you can take your earnings as a combination of salary and dividends. This blend of income is the current most tax-effective way to pay yourself. When you are employed, you don’t have this option.

The most tax-efficient way to pay yourself -UK contractor salary suggestion 

When considering what is the most tax-efficient way to pay yourself and, as part of this, when maximising the take-home pay and minimising your overall contractor tax rate, you could:

  • Pay yourself a contractor tax-efficient salary of £12,570 (this is the same as the personal allowance) per annum. This basic rate pay is the most tax-efficient salary (UK) if you don’t have any substantial income from other sources. Also, this salary level is enough to count as a qualifying year in terms of NI credits for UK state pension purposes. The £12,570 is a tax-efficient salary for directors 2023/24 and equates to £1,047.50 per month. With the most tax-efficient director’s salary 2023/24 set at this level, the director/employee will pay a small amount of employees’ National Insurance contributions (NIC). In contrast, the employer pays a minor amount of employer’s NIC. However, in 2023/24, it’s only more tax effective to take a contractor tax-efficient salary 2023/24 of £12,570 per annum if you don’t have other income i.e. rental, self-employment or pension income etc which use up your personal allowance.
  • In addition to your basic rate salary, your company makes dividend payments of £37,692 over the tax. In turn, this equates to a monthly dividend of £3,141. Alternatively, your company could make higher dividend payments if you take a lower director’s salary 23/24.

Result

As a result, adding the annual salary and the annual dividend would give total earnings just under £50,270. This combination of salary and dividends is the most tax-efficient if you have a business and your total income is just under £50,270. Your overall contractor tax rate will also be lower than of you had taken a higher level of salary.

The most tax-efficient way to pay yourself as a director 

UK tax allowances 

When looking at how to maximise your tax allowances, the personal tax allowances that are available to you are as follows:

  • Your tax-free personal allowance 23/24 is £12,570.
  • Your dividend tax-free allowance 23/24 is £1,000.

There is also an option to claim part of your married couple allowance if you’re married or in a civil partnership. This isn’t available for everyone and is only beneficial if one partner is a basic rate taxpayer and the other partner doesn’t use up their personal tax allowance (£12,570 pa). Therefore, the BR taxpayer will need to earn under the UK higher rate tax band (£50,270 pa) to qualify for the marriage allowance claim.

Work out the tax and limited company take-home pay 

When you pay yourself tax efficiently and maximise your basic rate tax band, you can consider which tax bands cover which types of income. Therefore:

  • Your personal allowance covers the £12,570 salary we show above.
  • First, you need to take your personal allowance of £12,570. Next, deduct from this the £12,570 above and the result is £0.
  • Finally, take the dividend figure above of £37,692 and deduct £0 of personal allowance left and the £1,000 dividend allowance this leaves £36,692 taxable dividends. Therefore, if you multiply this by the UK basic rate of tax on dividends (8.75%), it gives £3,211.
  • In conclusion, the tax-efficient result is the tax you pay as personal tax is £3,211 out of income totalling £50,262 leaving a contractor take-home pay of £47,051. Regarding the tax, you will pay this via your Self-Assessment tax return later. Your overall contractor tax rate here will be less than if you had paid any level of higher salary shown in the example above.

The most tax-efficient way to pay yourself -monthly earnings and tax savings 

When you look at how to operate with limited company tax efficiency, as shown in the scenario above, this’ll result in:

  • First, you can take a monthly salary from the company bank account of £1,047.50.
  • Second, your monthly dividend from the company account is £3,141.
  • You’ll need to save £3,211 divided into 12 = £267.58 per month to cover your personal tax that you’ll need to pay later. Personal tax is payable to HM Revenue & Customs via your Self-Assessment Tax Return.
  • In short, £1,047.50 plus £3,141 minus £267.58 = £3,920.92 net earnings each month (£47,051 per annum) -you have maximised your BR tax band.
  • To sum up, this’ll leave the director’s gross income just under the BR rate tax band of £50,270 pa.

One key aspect that may need considering is if you have other taxable income. Such income could include property income, bank interest, other dividends, capital gains transactions etc. If you do, you might consider a lower monthly salary, such as above the lower earnings limit (LEL) of £533 per month for 2023/24. The secondary threshold (ST) starts at £758 per month while the primary threshold (PT) starts at £1,048 per month, as highlighted above. A salary under £1,048 per month won’t incur employees NI however employer’s NI begins at £758. For a more in-depth view of salary considerations when you run your UK company, please read our guide on contractor salary.

Other considerations around the most tax-efficient way to pay yourself 

Income from other sources 

It may be the case that you might have other income when you consider the most tax-efficient way to take money out of a company. Such income could include rental profits, bank interest, or other dividends. Therefore, any other income will need to be considered when working out how to pay yourself as a business owner tax efficiently.

Higher rate tax band (UK)

You can maximise your BR tax band as described above; however, if you, as an individual, personally earn more than £50,270 in 2023/24:

  • Dividends that fall in the higher tax band (UK), i.e., above £50,270, are taxable at 33.75%.
  • If you earn above £100,000 as your personal taxable income, you start to lose your personal allowance the more that you earn. You’ll effectively lose £1 or your personal allowance for each tax-adjusted £2 of income that you make above this.
  • When you earn more than £125,140, you’ll be one of the additional 45% tax band taxpayers in the UK. Therefore, you’ll pay tax at the additional rate tax band, which is currently 39.35% on dividends.

Director’s loans 

When you take money from your company, besides repaying expenses and net salaries, other withdrawals are usually be classed as dividends. When we consider how to pay yourself on a tax efficient basis, another consideration is to take a temporary loan from your company. Basically, if you need to draw more than what is shown in the example above, you could treat any excess as a payment to your director’s loan account. This’ll be a temporary loan to the director (you) however you need to ensure that you repay this in the future. When you have a director’s loan, there may also be two potential tax implications depending on how much you borrow and how long you borrow this for.

Final thoughts 

The guide above shows the position quite nicely for 2023/24 regarding how to maximise your basic rate tax band as a UK contracting professional. It also explains at the same time how to be tax-efficient (UK) as a contractor or limited company owner. Those who work for themselves can make use of their personal tax bands. Indeed, these are some of the best things to do, financial wise. It’s also a good idea to minimise tax in the higher tax band, when you’re able to so.

If you follow the advice in this guide regarding claiming all genuine costs and setting your salary at an efficient level, you’ll improve your contractor tax rate. However, you’ll need to do further workings to help you decide on the most tax-efficient way to pay yourself from a company if you have any other sizeable sources of other income.

There could also be other things to consider if you live in Scotland and are subject to the Scottish tax bands.

In the future, we’ll continue to update this guide to show how you can operate with limited company tax efficiency. This’ll occur when the UK tax allowances, tax bands and rates change.

And finally…

Besides showing how you can calculate the what is the most tax-efficient way to pay yourself, there’s many other good reads for UK contracting professionals on this website. These cover how salary, paying your spouse, dividends, expenses, company profit, and many other areas work. They also demonstrate how you can run your company with tax efficiency, lower your overall contractor tax rate, save tax as you go along and what to watch out for when running your contractor business.

Finally, if you have worked at several different employers in the past and have various pension schemes, you may be interested in pension consolidation.

Link to Contractor Advice UK group on

LinkedIn    https://www.linkedin.com/groups/4660081/

Published On: January 4th, 2024 / Categories: Contractor Tips, Main Guides, Most Read Articles, Running Your Own Company, Tax Saving Guides /

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