How to Pay Yourself From a Limited Company

A limited company is a distinct legal entity from its owners, requiring formal processes for owners to extract funds. This separation means personal and business finances must remain separate. Owners must implement structured payment approaches, ensuring compliance with tax regulations and maintaining clear financial records. This structure is different from that of a sole proprietorship, where the owner’s personal and business assets and liabilities are generally not separated. The methods for an owner to receive money from a limited company are specific and involve careful consideration of their nature and tax implications.

Primary Methods of Remuneration

Owners of a limited company can receive remuneration through various methods, each with distinct financial and tax characteristics. Understanding these differences is fundamental to managing personal income from a business.

A common method is a salary or wages, compensation paid for services rendered as an employee. A salary is a tax-deductible expense for the company, reducing its taxable income. For the individual, salary payments are subject to federal income tax withholding and FICA taxes.

Dividends represent another way owners can receive funds, typically as distributions of the company’s accumulated profits to its shareholders. Unlike salaries, dividends are not a business expense for the company and are not tax-deductible. They are paid from the company’s after-tax profits and are generally taxed at preferential capital gains rates for the individual.

A director’s loan account records money exchanged between the director and the company. If the account becomes overdrawn and is not repaid promptly, it can have tax implications, potentially being treated as a taxable distribution or compensation. Maintaining clear records is important to avoid adverse tax consequences.

Expense reimbursements allow the company to repay an owner for legitimate business expenses paid personally. These reimbursements are not considered taxable income for the individual and are tax-deductible for the company if properly substantiated. Expenses must be ordinary and necessary for the business and supported by documentation.

Implementing a Payroll System

Establishing a payroll system is a requirement for a limited company that pays salaries or wages. The initial step involves registering as an employer with the IRS to obtain an Employer Identification Number (EIN). An EIN is a unique nine-digit number used by the IRS to identify business entities for tax purposes. This number is essential for filing tax returns and hiring employees.

Once an EIN is secured, the company must collect employee information, including a completed Form W-4, to determine federal income tax withholding. State and local tax identification numbers may also be necessary. Businesses also need to establish a pay schedule.

Calculating gross pay involves determining total earnings before deductions. Mandatory deductions include federal income tax, Social Security tax, and Medicare tax. These FICA taxes are split between the employer and employee, with the employer paying a matching portion. State and local income taxes are also deducted.

After calculating deductions, net pay is determined, and payslips are issued detailing gross pay, deductions, and net pay. The company is responsible for remitting withheld taxes to the IRS and relevant state agencies. Federal tax deposits are typically made electronically through the Electronic Federal Tax Payment System (EFTPS).

Regular reporting obligations include filing Form 941, Employer’s Quarterly Federal Tax Return, to report federal income tax, Social Security, and Medicare taxes. Annually, the company must issue Form W-2 to the owner and file Form W-3 with the Social Security Administration.

Declaring and Paying Dividends

The formal process of declaring and distributing dividends involves several steps, ensuring compliance with corporate governance and tax regulations. A prerequisite for dividend distribution is the presence of sufficient distributable profits. These profits represent the accumulated earnings available for distribution to shareholders.

Once distributable profits are confirmed, the board of directors must formally declare the dividend. This declaration typically occurs during a board meeting and must be documented in the company’s official board minutes. The minutes should specify the dividend amount per share, total dividend amount, record date, and payment date. The declaration date establishes the company’s legal obligation to pay the dividend.

Following the declaration, dividend vouchers or certificates must be prepared for each shareholder. These documents serve as official records for both the company and the individual, detailing the dividend amount received.

Recording dividend payments accurately in the company’s accounting records is critical. On the declaration date, the company debits its retained earnings account and credits a “dividends payable” liability account. On the payment date, the “dividends payable” account is debited, and the company’s cash account is credited.

Dividends are typically paid to shareholders on the designated payment date. While quarterly payments are common, some companies distribute dividends monthly, semi-annually, or annually. Special dividends can also be issued. For tax purposes, the shareholder generally must receive it within the taxable year.

Managing Other Payment Mechanisms

Proper management and record-keeping are essential when utilizing director’s loan accounts and expense reimbursements to ensure tax compliance and financial clarity. These mechanisms are common ways for owners to interact financially with their limited company. Adhering to established procedures helps avoid potential tax complications.

For a director’s loan account, every transaction must be accurately recorded. Maintaining a clear ledger is important to track the balance. If the director borrows money from the company, it becomes an overdrawn balance. Sustained or substantial overdrawn amounts can be recharacterized by tax authorities as taxable compensation or a dividend if not repaid within a reasonable timeframe. This could lead to unexpected tax liabilities.

Expense reimbursements require a system for documentation and processing. To qualify as non-taxable to the owner and deductible for the company, reimbursements must fall under an “accountable plan.” An accountable plan requires expenses to have a business connection. The owner must substantiate these expenses with documentation detailing the amount, date, place, and business purpose.

Documentation should be submitted within a reasonable timeframe. Any excess advances or reimbursements must be returned to the company within a reasonable period. Common reimbursable expenses include travel, meals, office supplies, and mileage. Failing to meet these accountable plan rules can result in reimbursements being treated as taxable income.