How Much Should I Take As A Salary From My Limited Company?
For self-employed workers, starting a limited company is most often a practical choice. However, there are a lot of factors that you need to consider.
One of the greatest differences between being employed and operating your own business is deciding how your limited company will pay you. Typically, the most tax-efficient way of doing this is to combine your salary and the dividends that you obtained from your limited company. Keep in mind that this salary is paid to you while working as a director and a regular employee at the same time.
You have to ensure that you can satisfy all the reporting and tax filing responsibilities needed for operating your payroll based on the rules implemented by HMRC’s Real-Time Information (RTI), otherwise, you may be charged with fines and penalties. However, if you’re a sole trader then the circumstance is different.
Why Take A Salary?
So, why should you take a salary from your own limited company? Usually, there are two major reasons why. First and foremost, it is counted as an allowable business expense. This means that this can help in reducing the amount that you need to pay for the Corporation Tax.
In case the salary is over the Lower Earnings Limit, which is £6,136 for the 2019/20 tax year and £6,240 in the 2020/21 tax year, then you can you increase qualifying years towards your state pension.
High Or Low Salary – Why Would I Want To Take A Low Salary?
Based on the rules of HMRC, people who don’t have a contract but holds a position at a company or receive regular wages, also known as “office holders” are not subject to the National Minimum Wage Regulations except if there is a contract of employment in place.
With a low salary, there is no need for paying Income Tax or National Insurance Contributions (NICs) for that salary.
If you are a UK taxpayer, then every year you can benefit from Personal Allowance. You are exempted from paying Income Tax if the income that you received is up to the Personal Allowance. The threshold is £12,500 for the tax years 2019/20 and 2020/21.
You also need to be aware of the National Insurance (NI) thresholds. Currently, they are lower than the Personal Allowance and are essential when deciding on your salary.
The Lower Earnings Limit
In case you set your salary above this level, then you will be able to keep your State Pension contribution record.
The National Insurance (NI) Primary Threshold
You must pay the employee’s NICs if you choose your salary to be below this level.
The National Insurance (NI) Secondary Threshold
Provided that your salary is less than this level, your limited company won’t be required to pay any employer’s NICs.
Hence, your goal should be to set your salary at a certain level that is over the Lower Earnings Limit. In this way, you can enjoy the benefits of qualifying for the state pension. But you also need to make sure that it is below the level where you are required to pay either employer or employer’s NI. This is definitely a win-win situation!
So, What Are The National Insurance Thresholds And How Can They Influence A Director’s Salary?
In case your salary is over the National Insurance (NI) Lower Earnings Limit which is £6,136, however, below the NI Primary Threshold which is £8,632, then there is no need of paying employee’s NICs, however, you could keep your State Pension contribution record.
In the 2020/21 tax year, the circumstance has changed after the government made an announcement that the Primary threshold for NI will increase to £9,500 from April 6, 2020.
With this change, for the 2020/21 tax year, we can expect that the NI Secondary threshold will be less than the NI Primary threshold. For the Secondary threshold, it is set at £169 per week or £8,788 per year from April 6, 2020.
One of the essential consequence of this development is that, for the 2020/21 tax year, we’ve figured out that setting your salary at the NI Primary threshold would indicate your company will be required to pay Employer’s NI. At the same time, the income of your company will be reduced due to the increased salary costs. Whenever there is a reduction in the company’s profits, the amount of dividend that will be distributed to your company’s shareholders will also be reduced.
Ultimately, we can say that the most tax-efficient salary for a limited company director for the 2020/21 tax year will typically be £732.33 per month or £8,788 for the 2020/21 tax year provided that he has no other sources of taxable income. Incidentally, this is also the amount for the NI Secondary threshold.
High Or Low Salary – Why Might I Want To Take A Higher Salary?
In case you decide to set your salary at a very low level, or if you refuse to take any salary, then there are some disadvantages.
Your maternity benefits will be lessened. Basically, you can only qualify for maternity benefits if you are employed and have followed the National Minimum Wage Regulations.
You won’t be able to use a portion of your tax-free personal allowance for a particular year in case your salary is already being paid at the NIC threshold and consequently, you don’t have any other sources of income. It is important to make sure that you understand the effect of the total amount of salary and dividends you acquire from your company as well as other sources of income on your tax-free personal allowance.
There will be a reduction in your cover for personal accident, critical illness, permanent health, and other similar policies, wherein the payouts are being computed based on your earnings.
If you choose to create a Contract of Employment for yourself, then you will probably be having some problems with the National Minimum Wage Regulations.
If you are planning to apply for a loan or a mortgage, then you have to meet certain criteria which may not be favourable to a low salary.
Paying Yourself In Dividends
Hopefully, in case your company makes a profit, then you will have two choices. You could either choose to reinvest your profit into the company or you could just take this out and pay shareholders by distributing dividends.
When we say “shareholders”, it simply means that they are the owners of the company. Hence, if you are the owner and the one who manages your limited company, then you can give yourself a dividend. Dividends have lower personal tax, making it a tax-efficient way of taking money out of your company.
Combining your salary with your dividend payments can assure you that you are at optimum tax efficiency.
Tax Implications Of Taking A Salary
When it comes to regular full-time employees, their salaries will be deducted by tax through the Pay-as-you-earn (PAYE). By having three separate PAYE taxes, the advantage of lessening your Corporation Tax liability by receiving a higher salary can soon be surpassed by the additional tax paid.
Your income tax for a particular tax year is accumulated on all your employment earnings as well as other sources of income. For instance, in a given tax year you have already received £10,000 from any employment, hence, your tax-free Personal Allowance will be deducted by this amount.
Employee National Insurance Contributions
Employee National Insurance Contributions (NICs) are not similar to Income Tax since they are not cumulative. Simply put, for any new employment, there is a separate income threshold before NICs are deducted. A limitation on the amount of NICs will be implemented for those employees who are paying a higher rate for their tax.
If you are a regular employee yet not the director of a company, then your threshold can be considered as the monthly amount. If you are paid by this amount in a particular month, then you will still pay NICs no matter if your pay for the remainder of the year is lessened.
If you are a director, then you will have a yearly threshold, this is equivalent to the weekly threshold amount multiplied by 52. When your salary goes over this, then you will pay NICs.
Employer National Insurance Contributions
When it comes to the threshold for employer NICs, it works just the same with the employees. For every salary that your employee earned, the employer needs to pay NICs which is set at 13.8% provided that it is over the weekly National Insurance earnings threshold. This is also applicable to your own salary if you are the director of your own company. Additionally, it also serves as another PAYE tax which the company needs to pay.
Putting It All Together
Taking into consideration all the above taxes that we have mentioned, in the 2019/20 tax year, it is typically more tax-efficient for limited company directors to choose a salary up to the Primary National Insurance threshold which is £8,632 in the 2019/20 tax year.
On the other hand, the salary should be set at £732.33 per month, which is the NI Secondary threshold. This is equivalent to £8,788 for the 2020/21 tax year.
As we have mentioned at the beginning, as the Lower Earnings Limit gets to the point wherein it is below employee or employer’s NICs, then you will still accumulate qualifying years for the state pension.
On the other hand, if you are choosing a salary which is over the relevant National Insurance threshold of your limited company, then you won’t be paying National Insurance or Income Tax on it provided that this is your only earnings.
This option is commonly recommended on the basis of tax efficiency. As outlined above, there might be some reasons why you might choose to have a higher salary as a company director. Being the director of your own company, you can decide the salary that you want to pay yourself. However, it is greatly recommended that you should get some advice from your accountant. In this way, you can always ensure that you are choosing your salary in the most tax-efficient way.