Company Directors - how to pay yourself
Although you and your company are separate legal entities, as a company owner you probably care very much how the company’s money is spent. You probably feel like the company’s money is your money even though there is a level of legal separation.
While there are different tax rules that apply to the company and to you personally, the ultimate aim is to use both these rules to best advantage and make a conscious choice on how you extract money out of the company to pay yourself. There are two options on this;
· Salaries
· Dividends
I will go through both these options and summarise at the end on what is the most tax efficient strategy for paying yourself.
Salaries
From a company perspective, salaries are a tax allowable cost for corporation tax, so they are paid out of the company’s pre-tax profit.
There is one relevant threshold for the 2021/22 tax year:
1. Secondary Threshold (National Insurance) – £8,788
Any salaries below £8,788 (the secondary threshold) will incur no national insurance contributions. Any salaries above this will incur NI contributions at 13.8%.
From a personal perspective, salaries are subject to income tax and national insurance.
There are three relevant thresholds for the 2021/22 tax year:
1. Lower Earnings limit (National Insurance) - £6,240
2. Primary Threshold (National Insurance) - £9,568
3. Income tax personal allowance - £12,500
A salary of at least £6,240 (above the lower earnings limit) is necessary to maintain your National Insurance record, and thereby protecting your state pension entitlement. A salary of less than £9,568 (the primary threshold) will incur no national insurance contributions for you as an employee. And a salary of less than £12,500 will incur no income tax as it is below the tax-free personal allowance.
Therefore if you pay yourself a salary between £6,240 and £9,568 you will incur no national insurance or income tax on your salary.
Salaries above £9,658 will incur national insurance contributions personally at 12% and salaries above £12,500 will also incur income tax at 20% for basic rate and 40% for higher rate.
So combining this with the info above on the company perspective, a salary between £6,240 and £8,788 will incur no NI contributions for the employee or the company and no income tax for the employee.
(If you come across any references to the Employment Allowance, this is no longer available to companies where there is just one director who is also the only employee).
Dividends
From a company perspective, dividends are not a tax allowable cost, so they are paid out of the company’s profit after tax.
From a personal perspective, dividends are subject to income tax only and because dividends are paid out of the company’s profits after tax, the income tax rates on dividends are lower than for other types of income. Dividends are taxed at 7.5% for basic rate and 32.5% for higher rate.
The first £2,000 of dividend income you receive is tax-free thanks to the annual dividend allowance. If you don’t use it, you lose it, and it cannot be carried forward.
Dividends are taxed at 7.5% for basic rate and 32.5% for higher rate, therefore once you have £50,000 of taxable income (from your company and other sources) you will pay 32.5% income tax.
If your total income goes above £50,000 you also start paying the child benefit charge if you are the highest earner in the household. Once your income reaches £60,000 all of your child benefit is lost.
And you need to be aware that your company can only pay dividends out of profits – so if your company makes a loss you cannot pay yourself a dividend.
Summary
In summary, assuming you are the sole director/employee of the company, then a small salary with dividend top ups is normally most tax efficient, assuming your company is your only source of income and your total income is staying below £50,000.
· Salaries less than £8,788 will incur no national insurance or income tax
· Salaries less than £12,500 will incur small amounts of national insurance and no
income tax
If your income is going above £50,000, well done you – let’s chat further as you will probably need a different strategy.
Although these small salaries can be tax free, they still have to be reported to HMRC as part of their normal payroll process. This will involve engaging an accountant or book-keeper to run a payroll process for you.