Salary Vs Dividends - Director Shareholder Renumeration
There are a variety of reasons why a business may choose to operate via a limited company. For others, the potential tax benefits are the main reason why they choose to be a limited company over a sole trader. Yet in this hunt to be the most ‘Tax Efficient’ in taking revenue, we need to consider the concept of Salary Vs Dividends for all Director/Shareholder remuneration.
Starting a limited company is often a sensible choice for self-employed workers, but it can present you with a lot of things to get your head around.
Salary Vs Dividends ?
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 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.
If you are a sole trader, you should read our article “ How to pay yourself as a Sole Trader ”
If a company pays salaries it will operate via the PAYE scheme and report to HMRC through the real-time information system (RTI).
You’ll need to make sure that you meet all your reporting and tax filing responsibilities for running your payroll under HMRC’s RTI rules or you may incur fines and penalties.
TAKING SALARY Vs DIVIDENDS
As a director and/or shareholder of a limited company, it can often be more tax-efficient to take your income as a mixture of salary and dividends. However, if you haven’t done this before, the process can quickly become confusing, to clearly differentiate this:
Director A director of a limited company is the person(s) that runs the company
Shareholder A shareholder of a limited company is the person(s) that owns the company
This can often be the same person(s).
A director can be paid a salary from the company through PAYE. However, shareholders (who are not directors) can only be paid with dividends.
If the director is also a shareholder he can be paid a salary through PAYE and also take dividends from the company.
What are the dividend tax rates for 2020-21?
Dividends are tax free up to £2,000.
Over £2,000, dividends are taxed at the basic rate of 7.5% up to £37,500
The higher rate of 32.5% is then applied to dividends taken between £37,501 to £150,000.
High or low salary – why would I want to take a low salary?
If you are the sole director and shareholder of a limited company, often the most tax efficient way for you to receive income is to take a small salary up to the National Insurance (NI) threshold, then take the remainder as a dividend.
The salary you process will be an expense to the limited company and therefore reduce your corporate tax, but it will be tax and NI free to you personally.
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.
A low salary can be paid which means you do not have to pay Income Tax or National Insurance Contributions (NICs) on that salary.
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 2019/20 and 2020/21 tax years this threshold is £12,500.
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:
What are the National Insurance thresholds and how do they affect a director’s salary?
For the 2019/20 tax year, if your salary is above the National Insurance (NI) ‘Lower Earnings Limit’ (£6,136) but below the NI ‘Primary Threshold’ (£8,632), you don’t pay employee’s NICs, but you do retain your State Pension contribution record.
The situation has changed in the 2020/21 tax year as the government has announced that the Primary threshold for NI will increase to £9,500 from 6th April 2020.
The change means that for the 2020/21 tax year the NI Primary threshold will be higher than the NI Secondary threshold. The Secondary threshold is £169 per week or £8,788 per annum from 6th April 2020.
One important impact of this change is that, for the 2020/21 tax year, we’ve calculated that setting your salary at the NI Primary threshold would mean your company will need to pay 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.
This means that the most tax-efficient salary for a limited company director with no other sources of taxable income for the 2020/21 tax year will usually be £732.33 per month (£8,788 for the 2020/21 tax year) which is the NI Secondary threshold amount.
What happens if I have other income?
If you have other income then taking a director’s salary may not be the most tax efficient option. If your other income breaches the thresholds, it may be better to only take dividends from your company, to avoid NI.
If your other income is below the thresholds, the difference can be calculated and put through as salary so all your allowances are used.
More than one director or shareholder?
If you’re running a company with an equal business partner or spouse then the same arrangement can be applied to them so that each of you receives a tax efficient sum.
An additional director means your company is eligible for the employer’s NI allowance. Therefore, the directors can run a salary up to the Personal allowance threshold, rather than the NI threshold and save more tax as a result. There will be some employee’s NI to pay but this is just 12%, with the additional salary being offset against 19% corporate tax.
However, it’s important to note that if your company has multiple directors and shareholders, with different ownership percentages, then the above arrangements will probably not be feasible.
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