As a limited company director, you have a great deal of flexibility over the way you remunerate yourself. Company owners can draw down income from your company in the form of a salary, and dividends.
Traditional employees are paid salaries, upon which income tax and National Insurance Contributions are payable.
Company owners, on the other hand, can elect to draw down small salaries, and take most of their income in the form of dividends. No National Insurance Contributions are payable on dividends, so the savings can be considerable.
The majority of limited company directors pay themselves a small salary, and draw down the rest of their income as dividends.
There are a few factors you should consider when setting your salary level.
- You pay no income tax up to £11,850 (the primary allowance), assuming you have no other sources of income during the tax year, and are entitled to the entire personal allowance.
- However, if your salary is higher than the Primary Threshold (£8,424 in 2018/19), then you must pay Employees’ NICs on this income, and the company must pay Employers’ NICs on all income above the threshold.
- How much salary have you already received in the current tax year from previous employment?
- If you have a contract of employment with your company (however unlikely this may be), you must pay yourself no less than the prevailing National Minimum Wage.
- You may need to pay yourself above the Lower Earnings Limit (£116 per week in 2018/19) to ensure you have a National Insurance record for the tax year in question, and that your entitlement to the state pension is unaffected.
- If you are not a sole director, or the only employee of your company earning above the Secondary Threshold (£8,424), you may be eligible to claim the Employment Allowance, a job-creating incentive which refunds up to £3,000 of Employers’ NICs each year.
For most contractors, the most tax-efficient salary level for 2018/19 is £8,424 – as no income tax or National Insurance is payable at this level. However, if your company is eligible to claim the Employment Allowance, you will be better off paying yourself and other employees £11,850.
The remainder of your contracting income will be drawn down as dividends.
Dividend tax is paid to HMRC via the annual self-assessment process, and the amount you pay will depend upon the taxable band you fall into.
From 6th April 2016, the entire dividend taxation system was reformed. The antiquated tax credit system was abolished, and replaced by the following tax rates: Basic (7.5%), Higher (32.5%), Additional (38.1%). Most contractors will pay more tax overall as a result of these changes.
In fact, a contractor on around £350 per day will pay £4,000 more in dividend tax per year following the overhaul of the taxation system.
You also have flexibility over the timing of dividend declarations. You may decide to hold off drawing down dividends until the following tax year, if you wish to avoid paying higher rate tax, for example.
If you are married, you may also benefit from splitting company shares with your spouse – especially if they do not already have another source of income. The spouse can receive dividend income up to the higher rate tax threshold without having to pay any tax at all.
For obvious reasons, you should discuss any questions relating to remuneration with your accountant, and do not rely solely on information contained on this site.