It’s that time of year again when thoughts turn to the optimum salary levels for the new tax year. As ever, this will depend on individual circumstances and this post is based on the following assumptions:
- Your only income is your salary/dividend from your limited company
- Your situation isn’t complicated by student loan repayments or child benefit
- Your income is below £100,000
- You are outside of IR35
In addition, Scottish tax payers will have slightly different tax bands in 2021-22.
For 2021/22 the personal allowance has increased from £12,500 to £12,570 – this means your first £12,570 of income is tax free. Also the higher tax band has increased from £50,000 to £50,270.
The tax rates for 2021-22 for earned income are as follows:
- Basic rate £12,570 to £50,270 20%
- Higher rate £50,270 to £150,000 40%
- Upper rate £150,001 + 45%
The dividend allowance remains at £2,000 (same as 2020/21) – this means the first £2,000 of your dividends are tax free. Over and above this £2,000, the dividend income is taxed as follows:
- Basic rate tax band 7.5%
- Higher rate tax band 32.5%
- Upper rate tax band 38.1%.
For limited company owner directors, it is a common strategy to take a low salary (just high enough to ensure that you receive your National Insurance credit for state pension purposes) with the balance taken in dividends. If possible, many people also choose to limit their total income to the basic rate threshold so that they are not subject to higher rate tax.
The advice on the most tax-efficient salary level also depends on whether there are other employees in the business. A few years ago, in an attempt to encourage small business to employ staff, HMRC introduced a National Insurance allowance which means that the first £4,000 of employer’s NI in the 21-22 tax year doesn’t have to be paid. However, this allowance is not available for single director employee limited companies.
For single director employee limited companies we would suggest a monthly salary of £736 per month, which means no national insurance deductions but you are protecting your entitlement to state pension. With regards to dividends, assuming you wish to take dividends up to the higher tax band but no further, we would suggest dividends of £41,450. At this level you shout set aside £2,678 towards your income tax bill.
If you are director of a company with other employees, we would suggest a monthly salary of £1,047. At this level you will have to pay national insurance but your company will be better off for the year.
Taking a low salary though does have some implications that you might want to bear in mind:
- Reduced maternity benefits – statutory maternity pay is based on your salary so reducing your salary will reduce your entitlement
- Reduced cover under permanent health, critical illness, personal accident or similar policies, where payouts are calculated based on your earnings
- When applying for a loan or a mortgage you may need to meet certain criteria which are unsympathetic to a low salary.
- Unforeseen things like Covid 19! A reduced salary in 2020-21 would have reduced your entitlement to funding if circumstances had lead you to be furloughed.
So as we said at the outset – there isn’t really a ‘one size fits all’ approach to the optimal salary / dividend structure. As a company director shareholder you can choose the amount of salary you’re paid and you may want to speak to us to make sure you’re paying yourself in the most tax-efficient way.