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Accounts Geek

Taking salary as a limited company director

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One of the differences between being paid by an employer and running your own business is having to sort out how your limited company pays you. Usually, the most tax-efficient way you can do this is by taking a combination of a low salary and dividends from your limited company. The salary will be paid to you as a director, in the same way as a regular employee.

You’ll need to make sure that you meet all your reporting and tax filing responsibilities for running your payroll under HMRC’s Real-Time Information (RTI) rules or you may incur fines and penalties. You’ll also need to make sure you follow HMRC’s rules on issuing dividends.

Why take a salary?

There are two main reasons to take a salary from your limited company:

  • It’s counted as an allowable business expense, which means it lowers the amount of Corporation Tax your company pays
  • If the salary is above the Lower Earnings Limit (£6,240 in the 2020/21 and 2021/22 tax years – view current tax rates) you accrue qualifying years towards your state pension.

High or low salary - why would I want to take a low salary?

You can pay yourself a low salary which means you do not have to pay Income Tax or National Insurance Contributions (NICs) on that salary.

It’s also worth knowing that under HMRC’s rules, ‘office holders’ (ie. people who hold a position at a company but don’t have a contract, or receive regular salary payments) aren’t subject to the National Minimum Wage Regulations unless there‘s a contract of employment in place.

As a UK taxpayer, each year you’ll have a Personal Allowance – any income you receive up to the Personal Allowance is free from Income Tax. In the 2021/22 tax year, the threshold is £12,570.

There are also National Insurance (NI) thresholds to be aware of. They’re all currently lower than the Personal Allowance and are important when setting your salary:

  • The Lower Earnings Limit – as long as your salary is set above this level, you’ll retain your State Pension contribution record
  • The National Insurance (NI) Primary threshold – as long as your salary is below this level, you won’t need to pay any employee’s NICs
  • The National Insurance (NI) Secondary threshold – as long as your salary is below this level, your limited company won’t need to pay any employer’s NICs

So, the aim is to set your salary at a level that is above the Lower Earnings Limit to obtain the benefits of qualifying for the state pension, but below the level where you’ll need to pay neither employee or employer’s NI. 

 

National Insurance thresholds and how they affect a director’s salary?

In the 2021/22 tax year the NI primary threshold is £9,568 per year and the NI secondary threshold is again at the lower level of £8,840.

For the 2021/22 tax year, setting your salary at the NI Primary threshold would mean your company will need to pay the Employer’s NI and your company’s profits will be reduced due to the increased salary costs. Any reduction in your company’s profits reduces the amount of dividends available to distribute to your company’s shareholders.

For the 2021/22 tax year the most tax-efficient salary for a limited company director with no other sources of taxable income will usually be £736.66 per month or £8,840 per year.

What are the disadvantages of low salary

  • When applying for a loan or a mortgage you may need to meet certain criteria which are unsympathetic to a low salary.
  • Issues with National Minimum Wage Regulations if you want to have a Contract of Employment
  • Reduced maternity benefits. Technically, to qualify for maternity benefits, you need to be “employed” and thus be compliant with the National Minimum Wage Regulations
  • Reduced cover under permanent health, critical illness, personal accident or similar policies, where payouts are calculated based on your earnings

Paying yourself in dividends

If you own (as a shareholder) 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 personal tax paid on dividends. However, you can only pay yourself a dividend If your company makes a profit.

Through combining dividend payments with a salary, you can ensure that you’re at optimum tax efficiency. The dividend tax-rate you pay is based on your total income from all sources, not just on your dividend income

However, if you don’t already complete an individual Self Assessment tax return, receiving dividends from your limited company may mean you need to complete one.

 

The annual tax-free UK Dividend Allowance

You can earn up to £2,000 in dividends in the 2021/22 tax year before you pay any Income Tax on your dividends, this figure is over and above your Personal Tax-Free Allowance of £12,570 in the 2021/22 tax year.

The annual tax-free UK Dividend Allowance only applies to income received from dividends. It was introduced in 2016 and replaced the previous system of tax credits on dividends. It’s intended to remove an element of double taxation as companies pay dividends out of taxed profits. The dividend tax rates are also lower than the equivalent personal tax rates. For this reason, as mentioned above, many limited company directors often use a combination of salary and dividends to pay themselves tax-efficiently

UK Dividend Tax Rates for the 2021/22 tax year

Once you’ve used up your Personal Allowance and the annual tax-free UK Dividend Allowance of £2,000, any further dividends you receive, from any source, will be taxed.

The amount of personal tax you pay on income from dividends is based on your tax band (also known as your ‘marginal rate’). The dividend tax rates you pay are lower than the income tax rates, which is one of the reasons dividends are so tax-efficient for limited company directors. The rates have not changed for a number of years and are as follows:

  • Basic-rate taxpayers pay 7.5%
  • Higher-rate taxpayers pay 32.5%
  • Additional-rate taxpayers pay 38.1%.

 

UK Dividend Tax thresholds for the 2021/22 tax year

In the 2021/22 tax year the following dividend tax rates and dividend tax thresholds apply after the Personal Allowance of £12,570 is used.

Basic rate (7.5%) – from £2000 to £37,700

Higher rate (32.5%) – from £37,701 to £150,000

Additional rate (38.1%) – from £150,000 

 

What is the maximum you can take in salary and dividends without paying Higher Rate tax?

In the 2021/22 tax year the followi

20th December 2021

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