If you are a director shareholder in a small company, you may have a great deal of control over how you take remuneration and dividends from your company and for many years the small salary plus dividends route has been seen as the optimum tax efficient package.
You could decide to cover your £12,570 personal allowance with salary and then take £37,700 the remainder of your £50,270 basic rate tax band, as dividends. However, this will trigger relatively small amounts of employee’s and employer’s NIC, which can easily be avoided.
A salary of up to £797 per month?
In the 2021/22 tax year, a salary of £8,844 paid as £737 per month is the amount that will ensure there is no PAYE, no employees NIC and no employers NIC. It will count as a qualifying year for state pension purposes.
A salary of £9,564 per annum, or £797 per month is the amount that will ensure there is no PAYE and no employees NIC but employers NIC of £8.28 per month is payable at 13.8% on the amount between £737 and £797.
So, perhaps if your company is already paying PAYE and NIC for other employees, it might make sense to go for £797 but if all the employees are directors and happy with the smaller salary, then pay just £737 per month and avoid all national insurance.
£2,000 of tax free dividends
Once again in the 2021/22 tax year the first £2,000 of dividends are tax free, after which dividend tax at 7.5% applies on dividends that fall within the £50,270 basic rate band, 32.5% in the upper rate and 38.1% in the additional rate band (above £150,000).
Why you might want a higher salary and lower dividends
- If the business has been loss making through lockdown, it might be wise to avoid dividends that could be clawed back if the business fails
- An £8k or £9k salary might not work for mortgage, or death in service life and permanent health insurance purposes
- If you are involved in R&D activities and qualify for R&D tax credits, taking remuneration as salary can have huge R&D tax benefits
- Shareholder agreements or other commercial agreements might restrict your options for paying dividends
- Pension contributions are restricted to earned salary income – although company contributions to director shareholders can in certain circumstances exceed this
Maximise your £50,000 basic rate tax band
So, for some director shareholders the optimum may be a salary of £737 per month and £41,400 of dividends all falling within their basic rate tax band. The effective rate of tax for this mix of salary and dividend is just over 6%!
Martin Gibbs is Dafferns Managing Partner and specialises in advising small and owner managed businesses – to contact Martin, please click here