Optimal Salary 2020-21

Collier-Marsh Accountancy

Chartered Accountants



There are no changes to the personal allowance for 2020/21 tax year, with this remaining at £12,500.  The dividend allowance remains at £2,000. 


The rules regarding employment allowance remain unchanged with regard to Co's where there is only a single employee who is a director - the employment allowance is not available.  However the employment allowance is restricted, from 6 April 2020, to those employers whose employer NICs bill was below £100,000 in the previous tax year. Employers who are connected to other employers (such as companies within a group) will need to add together all of their employer Class 1 NICs liabilities incurred in the tax year prior to the year of claim to determine eligibility.  In addition, for those eligible,  the maximum Employment Allowance will be increased from £3,000 to £4,000 with effect from 6 April 2020.


Please note that the above, and examples below relate to UK taxpayers, but excludes Scottish taxpayers which are under devolved tax rules.  For further information for Scottish taxpayers please contact us directly.


Optimal Salary


The optimal salary for an individual will vary from person to person, and will be dependent on a number of factors, namely business income, income required by an individual, family members being involved in the business, and potential impact of National Living Wage, where a contract of employment is in place.


A common strategy is to take a low salary and a higher proportion of dividends for many small owner managed businesses.  The effective tax rates in respect of dividends are lower than paying a salary, and there are no NICs (employee or employer) payable on dividends, which in the past has made the use of dividends as a form of remuneration more attractive and tax efficient. 


Considerations:


  • It is important to pay a salary over the lower earnings limit (LEL) for NICs in order to qualify for certain state benefits.  The LEL is £120 per week.
  • Employee's Primary class 1 contributions are paid when pay exceeds £183 per week and Employer's secondary class 2 contributions are paid when pay exceeds £169 per week.


Set out below are different scenarios showing the impact of tax and NICs.


Please note the following assumptions:

• Employment allowance is not available;

• There is no student loan balance;

• The only income is salary and dividends;

• IR35 is not relevant; and

• The company has sufficient distributable reserves, out of which the dividends can be paid. 


Example 1


The more tax efficient remuneration is to pay a salary above the lower earnings limits for NICs (this preserves the entitlement to state pension and benefits), but below the primary threshold for NICs, so that no NICs will be due.  As this salary will be below the personal allowance, no PAYE will be due.  The salary is tax deductable so will save corporation tax at 19%. 


Profit, before salary: £40,000


Salary: £6,240 (lower earnings limit - £120 x 52)


Remainder in dividends


















Example 2


An alternative is to take a higher salary, up to the point where Employer's NICs become payable, and the balance in dividends. 

 

Profit: £40,000


Salary: £8,788 (Employer's NIC Primary threshold - £169 x 52 - rounded down to ensure remain under the threshold)


Remainder in dividends


















Example 2 shows that individuals are slightly better off paying a salary up to the Employer's NIC primary threshold and the remainder in dividends. 


Note, that a salary of more than £8,788, as in example 2, will attract employer's NICs at 13.8%, which makes this option less tax efficient.


Remember that these examples do not take into consideration the employment allowance.  Where a business is still eligible for the employment allowance, it may still be beneficial to pay up to the personal allowance, as the employee NICs are offset by a larger saving in corporation tax.  Director's who are employed under an employment contract may need to be paid a salary in line with the National Minimum Wage.


Tax planning


  • Tax savings may be available through splitting of income with spouses or family members, via transfers of shareholdings.


  • Company pension contributions continue to be tax deductible for the company with no tax implications for individuals, up to the annual and lifetime allowance.


  • If the company is run from home, the director may be able to charge to company rent, although this would need to be declared as income is a self assessment tax return and taxed accordingly.  


  • A company can only declare a dividend, where there are sufficient distributable profits to pay the dividend. Where there are insufficient distributable profits to pay dividends, the dividend would be classed as unlawful.



For further advice or discuss your individual circumstances please contact us.









2020/21 tax year

£

Salary

6,240

Dividends (paid after corporation tax)

27,346

Total Gross income

33,586

Corporation tax

6,414

Employee NICs

0

Employer NICs

0

PAYE

NIL

Tax in dividends

1,431

Net income

32,155

Effective tax rate

19.6%


2020/21 tax year

£

Salary

8,788

Dividends (paid after corporation tax)

25,282

Total Gross income

34,070

Corporation tax

5,930

Employee NICs

0

Employer NICs

0

PAYE

NIL

Tax on dividends

1,468

Net Income

32,602

Effective tax rate

18.5%

Copyright © Collier-Marsh Accountancy

Collier-Marsh Accountancy, Old Coach House, Seagry Road, Sutton Benger, Wiltshire, SN15 4RX

Telephone: 01249 721 525 |  Mobile: 07583 437 689 | Email: contact@colliermarshaccountancy.co.uk