Corporation tax rates (20% and 24% – falling to 23% in April 2013) are lower than the top rates of income tax (40% and 50%), so company owners may save money by leaving their profits in the business. A small company pays tax at 20%, but the owners will pay more tax on the profits when they are paid out to them. Owners of unincorporated businesses (sole traders and partners) pay tax and national insurance (NICs) on all the profits the business makes whether those profits are left within the business or not.
NICs amount to an extra tax on salaries and business profits. Sole traders and partnerships can reduce the impact of NIC by forming a company and paying dividends on top of a small salary – dividends are not NICable. This is a complex decision, which should not be taken on tax grounds alone. There are more forms to file every year when running a company than an unincorporated business, but the tax savings may outweigh that.
There are alternative ways of taking money out of a company, but they can’t all be used in the same circumstances. Dividends can only be paid where there are accumulated profits in the company. A salary can be paid even if the company is making a loss, but a salary over the NI threshold of £7,605 (2012/13) will carry NICs. So the best course of action can change from year to year.
To maximise the amount you can take out from your company and minimise the tax charges, take some expert advice before the tax year end.