Working out the most tax-efficient way to draw down income from your company should be a priority for limited company directors. In this article, we explain how to work out the optimum salary level for the 2021/22 tax year.
Limited company directors
If you are a limited company director, you have a lot of flexibility over how and when you pay yourself and any co-directors.
Although the tax difference between company directors and traditional employees has reduced in recent years, one remaining tax benefit of incorporating is that dividends are not subject to National Insurance Contributions, whereas salaries are.
What is the optimum salary level for directors for 2021/22?
It is worthwhile drawing a salary from your company, as this cost is deductible against the company’s Corporation Tax bill.
However, the tax benefits of drawing a salary diminish as you pass through the prevailing income tax and NIC thresholds.
Here are some general factors to consider when working out your optimum salary level (and that of your spouse / other employees, if applicable):
a) £8,840 salary (tax-efficient, no NI)
- If you are entitled to the full personal allowance, you will not pay any income tax at all if your salary level doesn’t cross this threshold. For 2021/22, the standard personal allowance is £12,570.
- For the 2021/22 tax year, your company only starts paying Employers’ National Insurance Contributions when your annual salary reaches £8,840. Employees’ NICs are also payable, but only when your salary reaches the £9,568 mark.
- As a result, if your company is not claiming the Employment Allowance (see below), £8,840 is a tax-efficient salary to draw this year, with no National Insurance admin involved.
- Make sure you take into account any other income you have already received in the current tax year (for example, if you received a salary from a previous job or have rental or savings income).
- There is no legal requirement to pay yourself the National Minimum Wage unless you have a contract of employment with your own company which states otherwise (this is very unusual).
- This salary level is above the Lower Earnings Limit for National Insurance required in order to qualify for state benefits (for 2021/22, this is £120 per week / £6,240 per year).
b) £12,570 salary (most tax-efficient, if you can claim the Employment Allowance)
If you are not caught by IR35, and not the sole director/employee of your company earning over the Secondary Threshold, it may be tax-efficient to pay yourself a higher salary than £8,840 and claim the Employment Allowance (EA):
- The EA, which was first introduced in April 2014, will refund any Employers’ NICs your company pays, up to a maximum of £4,000. You must check with your accountant to see if your company is eligible (as most contractor companies are not).
- You will still have to pay Employees’ NICs on any salary of over £9,568.
- So, if your company pays you £12,570 during the current tax year, you will pay no income tax at all, the salary is deductible against your company’s Corporation Tax bill, and you’ll pay £360.24 in Employees’ NICs.
- The £514.74 Employers’ NICs will be refunded via the Employment Allowance (EA) scheme. However, you cannot claim the EA if you are the sole director of your company, and have no other employees.
- Your company will also save £708.70 in Corporation Tax if you decide to take a £12,570 salary instead of £8,840.
- You will be around £348 better off per year as a result of the corporate and personal tax savings compared to the £8,840 salary level.
- So, overall, you are better off paying yourself a £12,570 salary during 2021/22, if your company is eligible to claim the EA.
- You can find out more about the EA and see a calculation here.
Please note, that strictly speaking, a salary of £9,568 is more tax-efficient than £8,840 – by a few pounds. However, any tax savings made would be offset by the cost of accounting for National Insurance which is payable on the higher salary. So, we haven’t included that option here.
Umbrella company employees
If you are a PAYE umbrella company employee, your income will be subject to standard PAYE (Pay-As-You-Earn) income tax deductions and National Insurance Contributions.
Although there may be differences in service charges, and the value of ‘perks’ offered by different umbrella scheme operators, you should be subject to exactly the same levels of taxation. It is unethical for umbrella firms to claim otherwise.
What about dividends?
After you have decided upon the right salary level to pay yourself (and any employees) during the tax year, any remaining profits can be distributed to the company’s shareholders in the form of dividends, which are taxed as follows:
- 7.5% (basic rate)
- 32.5% (higher rate)
- 38.1% (additional rate)
There is also a £2,000 dividend allowance which sits within your existing tax bands.
Dividends are taxed as the ‘top slice’ of income, so after you have taken into account your salary, and any other earnings and investment income. Find out more in our guide to dividend tax.
- Find out more about what dividends are, and how to account for them in our detailed guide to limited company dividends.
- If you are starting out as a contractor, try our directory of accountants for some initial suggestions.
- Although the information contained on our site is verified by our own accountant, this article should be used as a guide only. Please contact your own accountant if you have any questions.