Sarah Bradford considers options for extracting profits from a company in a tax-efficient manner in the 2025/26 tax year.
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The family company is a separate legal entity from its directors and shareholders. If the family members wish to use the profits from the company personally, they will need to extract these from the company. It is advisable for this to be done in a tax-efficient manner.
Practical point
Employing family members can be beneficial where they have some or all of their personal allowance available, increasing the amount of profits that can be extracted tax-free and for minimal National Insurance cost.
It should be noted that there is no one-size-fits-all profit extraction policy, as what is optimal will depend on personal circumstances. However, there are some guidelines which can be followed and ‘typical’ extraction policies that are commonly adopted.
A popular tax-efficient strategy is to pay a small salary (see Section 5.1) and extract further profits as dividends (see Section 5.2). Profits can also be extracted in the form of benefits-in-kind, pension contributions or as rent, as part of a tax-efficient profit extraction policy (see Section 5.3).
Setting the salary level
A person needs 35 qualifying years to receive the full single-tier state pension and at least ten qualifying years to receive a reduced state pension. Where a family member does not already have the 35 qualifying years, it can be beneficial to pay a salary that is at least equal to the lower earnings limit, set at £6,500 a year for 2025/26 (equivalent to £125 per week, £542 per month).
For 2025/26, if the director-employee has their full personal allowance available, the optimal salary will be one equal to their personal allowance, which for 2025/26 is £12,570. This is the case regardless of whether the National Insurance employment allowance is available. However, where the employment allowance is not available, there will be some employer’s National Insurance to pay unless one of the upper secondary thresholds applies.
Practical point
Paying a salary between the lower earnings limit and the primary threshold will allow the employee or director to secure a qualifying year for zero primary contribution cost. However, depending on the employee’s circumstances, this may not be the most tax-efficient salary level. While paying a salary that is at least equal to the lower earnings limit will ensure that the year is a qualifying year for state pension and contributory benefits purposes, paying a higher salary can be more tax-efficient.
The optimal salary level will depend on whether, and the extent to which, the director-employee has their personal allowance available. Where the director has the standard personal allowance of £12,570 available in full, the optimal salary level for 2025/26 is £12,570.
Practical point
If the director-employee benefits from the marriage allowance, the optimal salary is one equal to the higher personal allowance of £13,830 for 2025/26, where this has not been used elsewhere.
Practical point
A company can pay a salary even if this creates a loss – there is no requirement for a salary to be paid from profits.
National Insurance employment allowance is not available
Assuming that the director-employee has their full personal allowance available to shelter any salary paid by the family company, the optimal salary for 2025/26 is one equal to the annual primary threshold of £12,570. As the primary threshold is aligned with the personal allowance, there are no tax or employee contributions to pay on a salary of this level for 2025/26.
For 2025/26, the secondary threshold is lower than the primary threshold and is set at £5,000. As this is less than the lower earnings limit for 2025/26 of £6,500, unless one of the upper secondary thresholds applies, in the absence of the employment allowance, it will be necessary to pay some employer’s National Insurance to ensure that the year is a qualifying one for state pension purposes.
Where the employment allowance is not available, there will be some employer’s National Insurance to pay to the extent that the salary exceeds the secondary threshold of £5,000 unless one of the upper secondary thresholds applies. Despite the secondary National Insurance hit, it is worth paying a higher salary equal to the personal allowance and annual primary threshold of £12,570 and paying employer’s National Insurance on earnings in excess of £5,000 at 15% (equal to £1,135.50). This is because salary payments and the associated employer’s National Insurance are deductible in computing taxable profits for corporation tax purposes, and the associated corporation tax saving outweighs the employer’s National Insurance bill. The corporation tax rate of between 19% and 25% is higher than the rate of employer’s National Insurance (set at 15% for 2025/26).
However, once the salary exceeds the annual primary threshold of £12,570, employee contributions are also payable at 8%, and tax is payable at 20%, meaning that the combined National Insurance and tax cost (after taking into account corporation tax relief on employer contributions) is more than the associated corporation tax saving of between 19% and 25%.
Practical point
Where the employment allowance is not available, employer’s National Insurance of £1,135.50 is payable on the optimal salary for 2025/26 of £12,570 unless one of the upper secondary thresholds applies. This is a hit worth taking as it is outweighed by the associated corporation tax relief on the salary in excess of the secondary threshold and the employer’s National Insurance.
Practical point
If the director-employee is under the age of 21, no employer’s National Insurance contributions are due unless earnings exceed the upper secondary threshold for under 21s, set at £50,270 per year for 2025/26. The same is true if the director is an armed forces veteran in the first year of their first post-forces civilian employment.
Where a higher secondary threshold applies, a salary of £12,570 can be paid free of employer’s National Insurance even if the employment allowance is not available.
Employment allowance is available
As long as the company has at least two employees in respect of whom secondary contributions are payable (or a single employee who is not a director), the company should be able to claim the National Insurance employment allowance to offset against employer’s Class 1 contributions (see Section 4.3). This is worth up to £10,500 for 2025/26.
Where the available employment allowance is sufficient to cancel out the employer’s National Insurance liability that would otherwise arise, as long as the director-employee has their personal allowance available to shelter any tax that would be due on the salary, the optimal salary level for 2025/26 of £12,570 can be paid free of tax and employer’s and employee’s National Insurance.
