Running a business comes with its fair share of challenges, and understanding how to extract cash from your company efficiently is a critical part of managing your wealth. This article explores seven effective methods for business owners to extract cash from their companies, alongside the tax implications of each method. It’s essential for business owners and directors to navigate these strategies to maximize after-tax income and ensure their financial decisions align with long-term goals.
1. Emoluments: Salaries, Bonuses, and Fees
The most common way for business owners to extract cash from their companies is through emoluments, which include salaries, bonuses, and director’s fees. These payments are subject to income tax, Universal Social Charge (USC), and Pay Related Social Insurance (PRSI) via the PAYE system.
However, there are some tax efficiencies available. For business owners who control 50% or more of the company’s shares, known as “proprietary directors,” the company avoids paying employer PRSI on the salary, saving 11.05% (11.15% from October 2024) of the amount paid. These tax savings are significant, but emoluments still attract high income tax rates, which can be less tax-efficient when compared to other methods of cash extraction.
2. Distributions (Dividends)
Distributions, commonly known as dividends, are another way to extract cash from a company. However, they are less tax-efficient than emoluments. Dividends are not deductible for the company, and there is a 25% dividend withholding tax, which the company must pay to Revenue within 14 days of the dividend being paid.
For shareholders, dividends are taxed at the marginal income tax rate, plus USC and PRSI. If the dividend is paid to a holding company, the tax treatment may differ, but dividends paid to individuals are generally subject to high rates of taxation. Despite this, dividends may be a preferred method when emoluments are not viable, as they offer some flexibility in extracting cash.
3. Loans to Directors
A company may loan money to a director under specific conditions. According to the Companies Act 2014, a loan can be made to a director as long as the total value of all loans to directors doesn’t exceed 10% of the company’s net assets. This method is more flexible but comes with tax considerations.
When a company extends a loan to a director, the company may face a withholding tax of 25% on the loan amount, which is refundable when the loan is repaid. If the loan is written off, it is treated as a distribution and taxed accordingly. Additionally, if the loan is offered at a preferential interest rate, a benefit-in-kind (BIK) tax will apply, increasing the overall tax liability.
4. Pension Contributions
One of the most tax-efficient ways to extract cash from your company is through pension contributions. Not only does this allow you to save for retirement, but contributions to pensions are also fully tax-deductible for the company. Employer contributions to a director’s pension are not subject to the same restrictions as personal contributions, offering significant tax advantages.
Pension funds grow tax-free, and with recent changes in legislation, employer contributions to a director’s Personal Retirement Savings Account (PRSA) are not counted against the director’s annual pension contribution limits. This means that business owners can make large contributions to their pensions, significantly reducing their taxable income and growing their retirement funds in a tax-efficient manner.
5. Termination Payments
When a director’s contract comes to an end, termination payments can provide a tax-efficient way to extract funds. The first €200,000 of termination payments are tax-free, and the remainder is subject to income tax at the applicable rate.
The tax-free portion of the termination payment is calculated based on the director’s years of service and final remuneration. There are various formulas to determine the exact amount of the tax-free portion, such as the Standard Capital Superannuation Benefit (SCSB) calculation. The director may also have the option to waive their tax-free lump sum to increase the tax-free termination payment, depending on their financial goals.
6. Share Buyback
A share buyback is another strategy for business owners to extract cash from their company. When the company repurchases shares from shareholders, the distribution is subject to capital gains tax (CGT) rather than income tax, USC, and PRSI, making it more tax-efficient. The CGT rate is 33%, which is much lower than the combined rate of income tax, USC, and PRSI, which can reach 52%.
For this treatment to apply, the shareholder must meet specific conditions, such as owning the shares for at least five years and reducing their holding by 25%. Share buybacks are often used as part of retirement planning or to remove a dissident shareholder from the business.
7. Liquidation
When a company is liquidated, its assets are sold, and the proceeds are distributed to the shareholders. This is typically a last resort for business owners, but it can offer a tax-efficient way to exit a business. The distributions made during liquidation are treated as capital gains, subject to CGT instead of income tax, USC, and PRSI.
The advantage of this method is the lower CGT rate, especially when combined with reliefs such as Entrepreneur Relief and Retirement Relief, which can further reduce the tax liability.
Conclusion
Tax planning is essential for business owners who want to maximize their after-tax income and grow their wealth efficiently. Each of the methods outlined above provides different advantages and disadvantages, depending on the business’s financial situation and the owner’s long-term objectives. It’s crucial to work with tax advisors to develop a strategy that aligns with both personal and business goals.
Whether through emoluments, pensions, loans, or liquidation, each method can help business owners reduce their tax burden and effectively extract cash from their company. However, careful consideration of the associated tax implications is essential for making the most of these strategies.
The National Pension Helpline offers expert guidance on tax planning and pension strategies for business owners, helping you navigate the complexities of financial management.
