For personal or family businesses, a popular strategy to make a profit is to take a small salary and then distribute the profits. What salary level should be pursued?
SALARY
Because it is a tax-deductible expense within your company, taking a small salary each year is tax-efficient. The downside is that if your salary exceeds certain thresholds, National Insurance becomes payable. This makes it less efficient than dividends. Here are some tips on how much you should be paying yourself.
National Insurance Credit
A minimum of PS6,396 salary in 2022/23 is required to be eligible for credit for the year. This credit will be used for contributory benefits and state pension purposes. This level is not eligible for NI, but you will still be eligible for credit.
Optimal salary
The employment allowance and the employee’s age will determine the optimal salary level. In the absence thereof, the optimal salary level for 2022/23 will be PS9 100 a year or HTML758 per month. This level does not require Employer NI or Employee NI, but it is still a qualifying year for State pension purposes.
Director could choose a slightly higher salary PS11908 or PSD992 per month. However, an employer NI fee will be payable. This is offset by a corporation tax savings. Above this level, it’s better to take dividends rather than paying a higher salary. The combined NI cost (28.1%) is greater than the corporation tax relief for salary payments.
You can get an exemption for the first PS5,000 of EmployerNI due in the current tax year if you are eligible to claim the employment allowance. If a single director company is not paid a salary, or if the majority of work is done for Public Sector clients, then you cannot claim the allowance. If the employment allowance is available or the employee is younger than 21, it is tax-efficient for the employer to pay the higher salary at PS11,908.
After 5 April 2022, can you incorporate your company?
If your company was incorporated during the tax year you will not be eligible for all of the threshold allowances. Therefore, the salary that you should receive in your first year of trading is lower than the levels above. To find out what your allowance is, please contact our Payroll Team.
DIVIDENDS
Dividends should be paid once the optimal salary has been reached to fully utilize the dividend allowance. Dividends are the best option if further profits are sought. However, the tax and NI costs of taking additional salary is higher than the corporation tax.
Reserves sufficient
Dividends cannot be paid if there are not enough retained profits. Reserves (or retained profits) are not always equal to the bank balance.
Tax not deductible
Dividends, unlike salary payments are not tax-deductible. They are paid from profits after corporation taxes (at 19%) have been paid.
Dividend allowance
Dividends are eligible for their own allowance. This allowance is PS2,000 for 2022/23 and is available to all individuals, regardless of tax rate. This allowance is available for dividends from all sources, not just your company. It also means that you can receive this amount tax-free.
Dividend tax rates
Dividends are subject to a lower tax rate than salary payments after the dividend allowance is used (8%, 33.75%, and 39.35% instead of 20%, 40%, and 45%). Your total income for the tax year determines the rate.
Use the basic rate band
Dividend income falling within the basic rate band for PS50,270 are subject to 8.75% tax. To avoid paying higher tax in the future, it is worth using your basic rate band every tax year.
Frequency
We recommend that dividends be paid on a quarterly basis. If possible, they should also be paid on an ad-hoc basis to minimize any HMRC challenge that they may not be comparable to salary.
Dividend income tax
Dividend tax is collected through an entry on your self assessment tax return. It will be due 31 January following the year in which it was paid. You may be required to make payments on account in respect of the current year. Blackman Terry can prepare your return for you. We are happy to assist you. This service allows us to assist you with HMRC tax codes and correct calculation of your account payments.
IR35
The fee-earner must receive income that is subject to IR35 rules as salary or pension contribution. Only income that is not subject to the IR35 rules can be used to pay salaries or dividends to shareholders.
PAYING OTHER PERSONS
Any employee of your company can be paid salary, including your spouse or children over 16, provided that you can prove to HMRC that the wage is fair.
Paying an employee who isn’t a director will result in pension auto-enrolment duties, if the monthly salary exceeds PS833
To maximize the dividends, it may be advantageous to make your spouse or civil partner a shareholder if they are in a lower income bracket. HMRC tried to regulate such strategies, which it calls ‘income shifting’. However, this has not been accomplished. It is legal to distribute income this way, even if there is no legislation.
TOTAL INCOME
Working for a company has many great advantages. One is the freedom it offers you to decide how much to make. To avoid higher tax rates, the basic rate band for 2022/23 will be PS50270. You may also lose child benefit if your income exceeds PS50,000.
Your personal allowance is lost if your income exceeds PS100,000. However, charitable donations and contributions to pensions will reduce this amount. The effective tax rate for income falling within the range between PS100,000.00 and PS125.140 can reach 60%. Keeping it below PS100,000.00 can help you save significant tax.
OTHER CONSIDERATIONS
To be able to afford your mortgage and to borrow in the future, you may need to keep a certain salary level. Lending to mortgages is based upon past and current salary levels. Not all lenders will accept dividends as an alternative to salary. Some lenders will only accept the P60 (certificates of pay, income tax, and national insurance contributions).
Dividends paid instead of salary can limit the personal pension contribution that you are permitted to make. We recommend that you consult with a financial advisor who can help you devise a remuneration plan. Alternately, your company could pay pension contributions on behalf of you. This can be tax-efficient as it lowers your corporation tax liability. If the company contributes, there is no salary restriction.
This should give you an overview of some important considerations when deciding on how much you want to earn. We are happy to assist you with any questions.