When running your own limited company a key point of your tax planning should be ensuring that you pay yourself the optimum level of salary and dividends. This advice is most relevant to limited company freelancers, contractors and micro businesses with 1-2 directors or shareholders.
Directors and Shareholders
Directors are appointed by the shareholders of a company and are paid a salary for acting as an officer to the company, doing day to day duties on behalf of the shareholders.Shareholders own the company through their shares and are paid dividends for their share in the profits.
Salary, Dividends and Tax
A salary is a fixed payment made to employees of a company which is paid on a regular basis. Dividends are money paid to the shareholders of a company out of its profits.
The current personal allowance is £12,500 which has increased by £650 from the previous years personal allowance. This means that the first £12,500 of income is tax free (subject to personal circumstances). Any amounts after this will be taxed as followed:
- £12,500 to £50,000 – 20%
- £50,000 to £150,000 – 40%
- £150,001+ – 45%
This, however, does not include dividends.
The dividend allowance remains the same as 2018/19 which means the first £2,000 for dividends will be tax free. Amounts beyond the dividend allowance will be the taxed as listed:
- The basic tax band, up to £50,000 – 7.5%
- Above the basic tax band, +£50,000 – 32.5%
- The upper tax band, +£150,000 – 38.1%
However, any unused personal allowance can be carried over and used against dividend income. Furthermore, your personal allowance and dividend allowance can be combined if your only income is from dividends.
Another tax that may need to be paid is National Insurance. The rates that most people in 2019/20 will pay for National Insurance:
- 12% if your income is +£166 a week
- 2% if your income is +£962 a week
National Insurance provides retirement pensions and other benefits.
Tax efficient salary and dividend 2019/20
For small business owners, freelancers and limited company contractors, taking a low salary with the balance of dividends is a common strategy of tax planning.The theory is:
- Withdraw a tax efficient salary lower than the personal allowance
- The salary is high enough so you will be liable to pay National Insurance and it counts as a years ‘stamp’ to enable future entitlement to state pension
- Corporation tax is saved by 19% (corporation tax rate for 2019/20) on the gross salary as it’s tax allowable.
- Any additional amounts withdrawn from your company would be treated as dividends and National Insurance will not need to be paid
- Dividends are NOT a tax allowable expense for a company.
An employment allowance was introduced in April 2014 which enabled employers to not pay the first £2,000 of any employers national insurance. The employment allowance is an annual amount that is currently available to all businesses, with some exclusions, to support the growth of smaller businesses and encourage them to take on more employees. Since being introduced, it has increased to £3,000 in and remains at that level for 2019/20.
What is the 2019/20 optimum level of Salary and Dividends
In 2016/17 HMRC announced that the employment allowance would not be available to companies where the only person on the payroll is a director, as a part of their attempt to encourage companies to employ more people. However this leaves uncertainty in situations where there are a husband and wife that are both directors with no other employees and taking a salary; it would appear to be okay, however it seems that HMRC is intending to stop companies with no ‘real’ employees from taking an employment allowance.In this situation we would advise only claiming the employment allowance if both individuals have active day-to-day roles.
If eligible for the standard personal allowance, take a gross salary of £12,500 annually to avoid paying personal tax. A rounded £464 of Employees National Insurance will still need to be paid. Any employers National Insurance tax may be covered by the employment allowance, under the assumption the £3,000 hasn’t been used up by employees salaries. If this is not the case, the next option may be a better idea for you.
In relation to dividends, if you took £37,500 (£50,000 minus £12,500) of dividends you will remain in the basic tax band and will subsequently pay minimal tax of 7.5% with £2,000 tax free from the dividend allowance. Personal tax paid will amount to £2,663 and leave you a net amount of £46,873.
For this option you will need to be aware of the following National Insurance thresholds; Lower Earnings Limit and Primary Threshold.As long as you earn above the Lower Earnings Limit, £118 a week, you will not need to pay National Insurance but your eligibility to state pension will still be protected.On the other hand, if you earn above the Primary Threshold, £166 a week and £8,632 annually, you will need to pay National Insurance.
It would be tax efficient if you earn £715 a month, £8,580 annually, as it will stay below the Primary Threshold. This will then leave £3,920 tax free dividends on top of the £2,000 dividend allowance. Therefore you will receive £5,920 tax free dividends; giving you £35,500 dividends which will be taxed at 7.5% as it is in the basic tax band . This means £2,663 will be paid in tax, leaving you a net amount of £47,338.
Although option 2 currently looks more appealing as there is more cash in your pocket, once corporation tax is factored into the equation, option 1 will be more tax efficient overall.Option 1 gives an overall saving of £281 on corporation tax, however it is not the most suitable route for everyone. Option 2 involves less admin processes, such as National Insurance being paid over to HMRC: this will be the preferred route for most.