This article is designed to provide limited company directors with the knowledge to structure their annual income; to ensure they are being tax efficient when deciding on the split of salary and dividend payments for the new 2020/2021 tax year (6 April 2020 to 5 April 2021).
From our experience this will be of particular interest to contractors, freelance consultants and micro business owners. These types of businesses normally have one or two director(s) & Shareholder(s) and it's exactly what TLA have become experts in advising upon during the last 10 years, therefore we're perfectly placed to support you and your business with the latest tax advice, in order to maximise your earnings.
We will first provide details of the tax free allowances & tax rates that apply to dividends and salary payments; which is set-out below:
Salary Tax Rates for 2020-2021The personal tax allowance has not been increased this year and remains at £ 12,500; which means the first £ 12,500 of your income is tax free.
- £ 12,500 to £ 50,000 - Income Tax Rate = 20%
- £ 50,000 to £ 150,000 - Income Tax Rate = 40%
- £ 150,000 or more - Income Tax Rate = 45%
Dividends
The annual dividend tax allowance has also not been changed and is £ 2,000; which means the first £ 2,000 of dividends paid is tax free. For dividend payments over £ 2,000 the income tax rates are:
- Total Income of Salary and Dividends £ 50,000 (Basic Rate Tax Band) - Dividends Tax = 7.5%
- Dividends paid over the Basic Rate Tax Band of £ 50,000 - Dividends Tax = 32.5%
- Dividends paid over the Upper Rate Tax Band of £ 150,000 or more - Dividends Tax = 38.1%
What is the most tax efficient level of salary and dividends; it depends:
For company directors the main variable to calculate how much to pay in salary is whether you employ staff in your company or not. Therefore, we have provided two options depending how your business operates.
No Staff are Employed (directors only)To utilise the annual tax free thresholds, we advise that you pay up to the maximum of £ 50,000 of combined salary and dividends (where possible), before any higher tax rates become payable; this would be broken down using the following remuneration package:
Payment Type
Annual
Monthly
Salary £ 8,784 £ 732
Dividends £ 41,216 £ 3,434 (Rounded down)
Less Tax Free * : - £ 14,500 - £ 1,208
Dividends Tax Due £ 2,663 £ 222
Total Income £ 50,000 £ 4,166* This amount of £ 14,500 is the annual income tax free threshold of £ 12,500, plus the £ 2,000 dividends tax free amount for the year.
The advised salary in this example is based on paying up to the Employers National Insurance (NIC's) threshold. This ensures you can offset the salary amount against your company profits and save 19% Corporation Tax, without paying any NIC's and most importantly this will give you a qualifying year towards your future state pension.
Please note that this example is based on paying up to the optimised level of £ 50,000. However, if you were to reduce the dividend payments to a level your business can sustain, you would pay 7.5% dividends tax on any dividends paid above £ 14,500 up to £ 50,000.
Your Limited Company Employs Staff
If your have employees the NIC allowances available are different from the above example, therefore we would need to look into your exact circumstances to provide you with tailored tax advice, to ensure tax efficiency for you and your limited company. We will calculate the split of salary and dividends that is most tax efficient, based on our analysis of your business and employee Income Tax and NIC's payable.
The reason for this is because if your business employs staff, it may be eligible to claim the annual £ 4,000 Employment Allowance (EA); which is a HMRC incentive for small businesses to employ more staff.
If this sounds like your current business position, please contact the TLA Payroll team for a review and we will be happy to assist you.
You will need to ensure you have a registered HMRC Payroll Scheme Please note, that in order to pay yourself a minimum salary and the rest in dividends, you will require a registered HMRC payroll scheme. The director salary amount(s) must be reported & submitted to HMRC, via an approvedpayroll system, under Real Time Information (RTI). If you are a TLA client, this will already be in place for you as part of our standard service. However, if you are not yet a TLA client, please call us to discuss your options to ensure you are fully compliant, should HMRC investigate the way that you structure your director salary and dividend payments.
Assumptions for the advice this article:
- You are UK resident for tax purposes, with a normal tax allowance of £ 12,500
- The only annual income your expect to receive this year is that of salary and dividends, via your limited company
