Whether you’re just starting out in business or are more established, you probably know to some extent that you can choose how to pay yourself to be as tax-efficient as possible.
But how do you navigate the tax landscape to ensure this is the case? And are there any other considerations which should influence your approach?
We’ll take a few moments to explain the issues, as well as share an optimum salary level for company directors in 2022/23.
The main considerations when assessing director salary rates
There are two main ways in which you can pay yourself as a shareholding company director: salary and dividends.
These are treated differently for tax and state benefit purposes, so when calculating your optimum approach there are several considerations to balance. These include:
- Your corporation tax liability
- Your employer and employee National Insurance liability
- Your income tax rate and personal allowance
- Your dividend tax rate and allowance
- Your entitlement to the state pension
A focus on dividends
Dividends are paid from profit and so will incur a corporation tax liability to your business whenever they are paid. The corporation tax rate is 19% at present and is due nine months after your company year end.
From a personal tax perspective, dividends are taxed at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.75% for additional rate taxpayers.
However, everyone has a dividend allowance which is £2,000 in the 2022/23 tax year. This can be used on top of the personal allowance for income tax. Dividend tax rates are favourable when compared to income tax.
Paying yourself dividends attracts no National Insurance liability, but does not build up any entitlement to state pension.
A focus on salary
In contrast to dividends, salary is considered a deductible expense for corporation tax purposes, so it will not attract the 19% corporation tax liability that dividends do.
You do face personal income tax, though, which is payable at 20%, 40% and 45% based on the basic, higher and additional rates. Everyone has a personal allowance of £12,570 which is free from income tax each year.
Importantly, salary is subject to employer and employee National Insurance, and can help you build up a state pension entitlement. It is the thresholds at which these all activate which drives how you should split your remuneration between salary and dividends.
National Insurance and state pension entitlement
To build up an entitlement to the state pension you need to pay yourself a minimum of £6,396 per annum.
This is called the lower earnings threshold. At this level, no employer or employee National Insurance contributions are due, even though you are accruing state benefits.
Employee National Insurance contributions become payable when salary reaches £11,908 (at 13.25%). This is called the primary earnings limit. Employer National Insurance contributions kick in at £9,100 (at 15.05%). This is known as the secondary earnings limit.
The optimum salary for directors
So, taking all of the above into account, the optimum salary which will allow you to build up your state pension while minimising tax liability is the primary earnings limit of £11,908. This works out at £992 per month. Then any remuneration above this can be paid as dividends.
You may notice that this incurs a little employer National Insurance liability as it is over the secondary earnings threshold. However, this still works out more tax-efficient than if you were to pay a salary up to the secondary earnings threshold of £9,100 and then switch to dividends, as the additional corporation tax liability would be higher than the National Insurance liability.
Further advice on director remuneration
It’s always worth speaking to an accountant to ensure that the suggested strategy is right for you, as there are a few nuances that may lead to a change of tack, and the rates can change from year to year.
If you would like to book a call with us to discuss your situation, please do not hesitate to get in touch.