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Optimum Level of Salary and Dividends

Date posted: March 26, 2018

For many businesses trading as a limited company, taking a low basic salary with the balance of income extracted as dividends, is a common tax planning strategy.

The theory is as follows:

  • You take a low tax efficient salary no higher than the personal allowance so that it does not attract personal tax.
  • You should make sure the salary is high enough for national insurance purposes i.e. that it counts as a year’s ‘stamp’ for your national insurance history to help protect your future entitlement to state pension and other benefits.
  • The salary is a tax allowable cost for your business so corporation tax is saved at 19% (corporation tax rate for 2018/19) on the gross (pre-tax) salary.
  • Any additional amounts you extract from your company are treated as dividends which do not attract national insurance, therefore you are not paying any more national insurance than you need to be.
  • Please note that dividends are not treated as a tax allowable expense (unlike a salary) so your company does not save corporation tax on the dividends.

Many people choose to limit their total income to not go into the higher tax band (£46,350 for 18/19) so they are not taxed at the higher levels of tax, but this will be a personal choice and a balance will need to be made between tax efficiency and how much of the available profits in your business you want to extract.

Salary

The introduction of the Employment Allowance in April 2014 enabled employers to not pay the first £2,000 of employers’ national insurance. This then increased to £3,000 for 17/18 and 18/19.

Typically the employment allowance means that it is slightly more tax efficient to take a gross salary all the way to the tax free allowance level (£11,850 for 17-18), however HMRC announced that from 16/17 the Employment Allowance will not be available to companies where the only person on the payroll is a director, i.e. ‘single director employee’ limited companies.

Unfortunately what they have left open as a ‘grey’ area is the situation where there is a husband and wife who are both directors taking a salary with no other employees.

As things stand it would appear this would be ok, however it seems to be that HMRC’s intention is to block companies that have no ‘real’ employees from claiming the employment allowance (the government are trying to encourage small businesses to take on employees).

Our stand on this currently is to lean on the cautious side – in the situation of a husband and wife director payroll we would advise only claiming the employment allowance if both parties have an active role in the day to day business.

There are two National Insurance thresholds you need to be aware of:

  • Lower Earnings Limit – as long as you earn above this you are protecting your entitlement to future state pension and benefits, without necessarily paying any National Insurance.
  • Primary Threshold – if you earn above this, you have to start paying National Insurance.

So the sweet-spot is to go up to the Primary Threshold but no higher.

The National Insurance Primary Threshold for 18/19 is, £162 per week or £8,424 for the year.

Therefore, we would suggest a monthly Gross Salary of £702 which stays just below this threshold.

Dividends

Dividends are taxed as follows:

The dividend allowance means that an individual’s first £2,000 of dividends are tax free.

Over and above this £2,000 the dividend income is taxed as follows:

  • If you have any un-used personal allowance £11,850 for 18/19 (£11500 17/18) then that element is tax free
  • Any dividends within the basic tax threshold and up to £46,350 for 18/19 (£45000 17/18) attract a tax charge of 7.5% (basic tax threshold = basic rate band + personal allowance)
  • Dividends above the basic tax band (£46,350 for 18/19) are charged at 32.5%
  • Additional rates of tax will apply at the upper tax band £150,000

Assuming you take a salary of up to National Insurance limit of £8424 (£8164 17/18) you can take dividends of £37926 (£36836 17/18)

This is because you have spare personal allowances, which together with the £5000 dividend tax free allowance, reduce the dividend amount which is subject to tax at 7.5%.  See the table below:

Tax Year 18/19 Tax Year 17/18
£ Annual £ Annual
Gross Salary 8424 8164
Dividends 37926 36836
Total Gross Income 46350 45000
Tax on Dividends (2438) (2138)
Net Cash in Pocket 43912 42863

Conclusion

Since we are fast approaching the end of the 17/18 tax year, consider whether you have fully utilised your personal tax allowance, your dividend tax free allowance and your basic rate band.

It may also be appropriate to look at who owns the share capital and consider gifting share to other members, such as spouses, partners or adult children