As a director of a limited company, you are probably keen to know the most tax efficient way to take money from the company personally. This is usually by taking a combination of salary and dividends from the limited company. The salary is paid in the same way you’d pay a regular employee and needs to be reported via the HMRC’s Real Time Information (RTI) rules.
With just a few months remaining until the end of the 2020-2021 tax year, there’s still time to manage your salary payments to ensure you receive the optimum salary.
Why should directors take a salary?
There are two main reasons to take a salary from your limited company:
- A salary is an allowable business expense, which means it lowers the amount of Corporation Tax your company pays.
- If a director takes a salary above £6,240 in the 2020/21 tax year, they will accrue qualifying year towards the state pension, which will affect how much State Pension you are entitled to.
What is the optimum salary for a sole director in 2020/21?
The optimum salary for a sole director on their limited company’s payroll, is £8,788 per annum.
This is because a sole director cannot claim Employment Allowance. Employment Allowance allows employees to claim up to £4,000 to cover the costs of employers National Insurance and to be eligible, employers need to have at least 1 employee or 2 directors on the payroll, and not have another company already claiming the Allowance.
What is the optimum salary for two or more directors on the payroll, in 2020/21?
If there are 2 or more directors on the payroll, then the Employment Allowance can be claimed. This means the directors can take a salary of £9,500 each without incurring National Insurance payments, if they are the only individuals on the payroll.
If you have 3 or more employees on the company’s payroll you will need to speak to your accountant or tax advisor regarding the most efficient level of salary to take from the business.
How much is your Personal Allowance?
Your Personal Allowance is the amount you can earn before you start paying income tax. In the 2020/21 tax year, the Personal Allowance is £12,500.
Considerations for your salary amount
When deciding on the level of salary you will pay yourself, there are other factors to consider:
- Consider any salary already earned in the relevant tax year from other work or previous jobs.
- Consider any other income such as from shareholdings or rental properties, for example dividends received from shares quoted on the stock exchange.
- Bear in mind that the value of your personal allowance is gradually withdrawn by £1 for every £2 you earn above £100,000 each tax year. This means that your entire personal allowance will have been removed by the time you hit £125,000 of salary.
- If you have a contract of employment with your company (which is unlikely but possible) then you must pay yourself the National Minimum Wage @ £8.72 per hour for adults aged 25 or above.
- Check with your accountant if there is a minimum salary required if you make contributions to a personal or executive pension scheme.
Should you pay yourself in dividends, a bonus or direct money into a pension scheme
If your company is loss-making and is without any retained profits, you will need to consider paying an increased salary or one-off bonus payment if you want to withdraw money from your business as in these circumstances it is not possible to declare a dividend.
If your company makes a profit then you have other options. You can reinvest your profit into the company, pay yourself additional salary or a bonus, or issue a dividend or direct additional income into a pension scheme.
Direct income into a pension scheme
Pension contributions can be made from your own personal funds, or directly from your company’s income. If paid from personal funds, the amount you can invest is determined by HMRC by the size of your salary. If you take a small salary and large dividends, the dividend income does not count toward your pension tax relief limit.
If you choose to make pension contributions from pre-taxed company income, these are “allowable expenses” so your business will receive tax relief, saving you up to 19% in corporation tax.
For bespoke guidance on this, call the HB team for personal advice on 01992 444466 or feel free to email by clicking here
Paying a dividend to a company director
If you own and manage your limited company, you can pay yourself a dividend. This can be a tax-efficient way to take money out of your company due to the lower income tax rates applied to dividends. Therefore, paying a dividend rather than increasing your salary will often be a more cost-effective way of withdrawing profits from a company.
For the current tax year, you can issue up to £2,000 of dividends tax free, tax is then incurred at the following rates:
- 7.5% on dividend income within the basic rate band (up to £37,500)
- 32.5% on dividend income within the higher rate band (£37,501 to £150,000)
- 38.1% on dividend income within the additional rate band (over £150,000)
The benefit of combining dividend payments with a salary to ensure optimum tax efficiency is slowly changing as the tax advantages of paying dividends diminish. It may be that paying a bonus could be more efficient, as a bonus can be deducted from company profits meaning corporation tax will be reduced. However, this must be weighed against the fact a bonus will be treated as employment income and therefore will attract PAYE and National Insurance contributions.
The timing of a bonus payment could help tax efficiency as PAYE and National Insurance is payable from the date on which the bonus is approved, even if the bonus is not actually paid until later. The actual bonus payment must be made within nine months of the end of the accounting period to which the bonus relates.
As ever, the answer to the most tax efficient way of paying a director is based on individual circumstances, timing and level of payment being made.
HB is here to help you find optimum tax efficiency: giving you access to experienced accountants and useful information and support no matter your business size or sector. If you would like a no obligation discussion about how we can help you, please feel free to contact the team on 01992 444466. We’re accountants for business and we’re here to help you grow.
We have been working hard to continue to keep you updated as the Government releases new information and are doing everything we can to support our clients during this uncertain period, please do not hesitate to contact us here if you have any concerns or queries.
Latest blogs from HB Accountants
- HB Director Karen Chase, talks to Love Hoddesdon about the BID and which events Team HB really love…
- HMRC’s new creditor status – how will it affect you?
- Celebrating Local Heroes and our new home
- No VAT on (some) B2C services to EU customers
- Self employed traders must respond to HMRC’s email or risk losing SEISS
The information contained above is for general guidance purposes only. Whilst every effort has been made to ensure the contents are accurate, please note that each individual has different circumstances and it is essential that you seek appropriate professional advice before you act on any of the information contained herein. HB Accountants can accept no liability for any errors or omission or for any person acting on or refraining from acting on the information provided in the above