We often get asked how do I pay myself and make sure I minimise the amount of tax and national insurance ?
In the case of a limited company the best way to extract money is a combination of dividend and salary.
For 2017/18 the dividend allowance means that the first £5,000 of dividends are tax free. Above this dividend income is taxed as follows:
- If you have any un-used personal allowance (£11,500 for 2017-18) then that element is tax free
- Any dividends in the basic tax band (up to £45,000 for 2017-18) attract a tax charge of 7.5%
- Dividends above the basic tax band (£45,000 for 2017-18) are charged at 32.5%
- Additional rates of tax will apply at the upper tax band (£150,000 for 2017-18)
If your only income was dividend income you could receive £16,500 of tax free dividend income in 2017-18.
Tax efficient dividend and salary structure
A low basic salary with the balance of income being extracted as dividends is a widely used planning strategy.
- You take a salary up to the personal allowance
- You ensure the salary is high enough to protect your entitlement to state pension & other benefits
- Corporation tax is saved on the salary as it is an allowable cost
- Additional amounts extracted from your company are treated as dividends and so do not result in national insurance being payable
Depending on your circumstances you may choose to limit your income so that you don't go into the higher tax band (£45,000 for 2017/18). This is your choice. The balance is between tax cost and the level of available profits you want to extract.
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What are the best levels of salary and dividends for 2017-18?
Employment allowance means that it is slightly more tax efficient to take a gross salary all the way to the tax free allowance level of £11,500 for 2017-18, However, HMRC announced that from 2016-17 the Employment allowance will not be available to companies where the only person on the payroll is a director.
The situation where there is a husband and wife who are both directors taking a salary with no other employees suggests entitlement to Employment allowance but it should be noted that HMRC’s intention is to block companies that have no ‘real’ employees from claiming the Employment allowance. Being cautious we would advise only claiming the Employment allowance if both parties have an active role in the day to day business. Therefore, for most contractors, we would advise against claiming the employment allowance. Option 2 would be preferred.
Below we outline two different salary and dividend options which assume that you wish to stay below the higher tax band of £45,000.
Key assumptions when preparing these calculations:
- UK resident and not a Scottish tax payer
- No student loan
- Only income is salary and dividend from your company
- You're outside IR35
- You have a standard personal allowance
- Your company has sufficient profits (after providing for corporation tax) to support these dividends
Option 1 – claiming the employment allowance (if allowed), more tax efficient with more administration.
Take an annual gross salary of £11,500 which is the standard personal allowance for 2017-18.
This level of salary will not attract any personal income tax, but it will attract some Employees National Insurance which will total approximately £400.
Employers National Insurance will be covered by the Employment Allowance, if you can claim it.
With regards to dividends, the higher tax band is £45,000 so if you want to stay in the basic tax band this leaves you £33,500 of dividends to take.
There will be personal tax to pay as the first £5,000 is tax free but after that they are charged at 7.5%.
See below table for illustration:
This equates to a monthly salary of £958 and dividends £2,790.
Any dividends taken above the higher tax band will be taxed at higher rates.
Option 2 – take a salary up to the NI primary threshold.
If you can’t claim the employment allowance or want to keep things simpler this is a good strategy.
As with Option1, assuming you wish to take dividends up to the higher tax band, then you can take slightly more dividends with Option 2 than with Option 1.
The dividend tax calculation for Option 2 - Salary £8,164 leaving £3,336 of dividends that can be taken tax free in the personal allowance. The next £5,000 of dividends are tax free being within the dividend allowance. This leaves dividends of £28,500 taxed at 7.5% = £2,138 of tax.
See below for how this works out with regards to net cash – it is the same tax amount as Option 1.
| 2017-18 Tax Year | |
|---|---|
| £ Annual | |
| Gross salary | 11,500 |
| Dividends | 33,500 |
| Gross income | 45,000 |
| Employee national insurance | (400) |
| Tax on dividends | (2,138) |
| Net cash | 42,462 |
| 2017-18 Tax Year | |
|---|---|
| £ Annual | |
| Gross salary | 8,164 |
| Dividends | 36,836 |
| Gross income | 45,000 |
| Tax on dividends | (2,138) |
| Net cash | 42,863 |
The net cash is higher in Option 2 (by £401) however this doesn’t allow for the additional corporation tax saved on the higher Gross salary in Option 1.
The table below compares Options 1 and 2 and shows that overall Option 1 is more tax efficient by £234.
| 2017-18 Tax Year | ||
|---|---|---|
| £ Annual | ||
| Option 1 | Option 2 | |
| Gross salary | 11,500 | 8,164 |
| Dividends | 33,500 | 36,836 |
| Total gross income | 45,000 | 45,000 |
| Employee national insurance | (400) | 0 |
| Tax on dividends | (2,138) | (2,138) |
| Net cash | 42,462 | 42,863 |
| Corporation tax saved on gross salary | 2,185 | 1,551 |
| Overall saving - Option 1 | 234 | |
For limited company contractors Option 2 is recommended. This equates to a monthly salary of £680 and dividends £3,070. It also has the added benefit of less administration as no national insurance needs to be paid over to HMRC.
Salaries need to be below £10,000 to be ineligible for auto enrolment. This is important if your staging date is in 2017-18.
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