What is the optimum salary for Directors for the year ahead?
With the 2022-23 tax year starting 6 April, it is important to get your finances in order, including considering the salary that you should be paying yourself from your business, to maximise savings.
What should be considered when determining optimal salaries.
Personal allowance
As previously announced this is frozen at £12,570 per year until the April 2026 (or at least the election).
National Insurance
During the Spring Statement, the Chancellor announced changes to the National Insurance thresholds for employees, which are set to impact the calculation of the optimum Director’s salary.
From July 2022, the Primary Threshold (PT) for National Insurance will be increased from its already announced 6 April 2022 position of £9,880 to £12,570 (bringing parity with the tax-free personal allowance threshold).
Another consideration is the Secondary Threshold for employer NICs, which will only rise to £9,100 in April for 2022-23. Additionally – regardless of how far away it may seem – it is important to plan for your retirement.
For the approaching tax year, an annual salary must be at least £6,396 (the lower earnings limit) to meet the qualifying contribution requirements for the state pension.
Find out more about National Insurance thresholds here.
Employment Allowance
Some businesses may be eligible to receive employment allowance, which could reduce the amount of NICs that are due.
You can claim Employment Allowance if you’re a business or charity (including community amateur sports clubs) and your employers’ Class 1 National Insurance liabilities were less than £100,000 in the previous tax year and there are at least two people on the payroll.
For 2022-23, eligible companies may be able to reduce the liability by up to £5,000 per year – an increase of £1,000 on the previous tax year.
Corporation Tax
This remains unchanged at 19% for the 22/23 financial year, increasing to 25% from 1 April 2023.
What are the benefits of paying a salary?
A salary is considered a tax-deductible expense and so a company can deduct tax at 19% (the current Corporation Tax rate).
Furthermore, the payment of a salary above the Lower Earnings Limit ensures the individual makes sufficient qualifying contributions to achieve a qualifying year for the State Pension (often without actually contributing anything).
How much should I pay myself?
There are 3 scenarios to consider.
- One-person director only companies, where there is no option of claiming NIC employers’ allowance as this is limited to companies with two employees of higher.
Companies can pay directors’ salaries up to the Secondary Threshold (the level at which employers must begin making contributions), which is £9,100 (2022/23), or £11,908 (the level at which employees must start their own contributions).
Paying a salary at this £9,100 avoids PAYE, employees NI and employers NI and is the most straight-forward.
However, an optimum salary of £11,908 saves more in Corporation Tax than is lost through the employer’s NICs, as illustrated in the below example.
With a £11,908 salary, the extra employers’ NI suffered totals £422 (£2,808 at 15.05%) but the corporation tax saved totals £613 (extra £2,808 salary at 19% plus the NIC of £422 on this salary at 19%).
The downside with incurring employers’ NICs of £422 is that the payments will need to be made either monthly or more likely quarterly to HMRC.
For some businesses, this additional admin may not beat the total saving of around £191 per year, but this is a decision that Company directors will have to make following these changes.
Furthermore, the tax savings are actually tied up in the Limited Company (which may be subject to further tax before extraction), rather than actual cash in your pocket today.
- Two-person director only companies, where there is the option of claiming NIC employers’ allowance.
Again, paying a salary at this £9,100 avoids PAYE, employees NI and employers NI and is the most straight-forward.
However, an optimum salary of £12,570 saves £572 per director as illustrated in the below example.
With a £12,570 salary, the extra employers’ NI suffered is covered by the employment allowance. The corporation tax saved totals £660 (£3,470 extra salary at 19%). The NIC suffered on the extra salary is £88.
Again, there is the admin of making the NIC payments to HMRC and the savings are tied up in the company (which may be subject to further tax), rather than actual cash in your pocket.
However, for businesses where there is the ability to claim employment allowance the savings are even higher.
- Companies with non-director staff & where NIC employers’ allowance fully used via staff.
This is actually the same scenario as the first director-only position. The optimal salary is £11,908, however since you are likely already paying HMRC for staff deductions, the admin hassle is not really an issue.
Why not pay salary at the personal allowance level? (£12,570)
Unfortunately, in scenarios 1) and 3) above, as employers’ NIC would be due at 15.05%, and employee’s NIC at 13.25%, this would exceed the 19% corporation tax savings made, so would not be optimal.
But I can’t live off £11,908!
Of course, an annual salary of £11,908 would not be enough for most individuals to support their needs, especially with the current cost-of-living crisis, which is why earnings would need to be topped up with dividend payments that face lower tax and NI rates.
After paying a salary (at either £9,100, £11,908 or £12,570 per above), the remainder of the personal allowance – if any – would be available as a tax-free dividend. Then the dividend allowance of £2,000 would be tax-free (assuming no dividends earned elsewhere)
Any dividend income above these amounts will then be taxed at the appropriate rate, i.e. basic rate dividends (up to £50,270 income in total) are taxed at 8.75%.
Income above this will see dividend tax rates rise to 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers.
As you can see, the setting of tax-efficient salaries and other remuneration for directors can be challenging. For support with related matters, please contact us today.
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