As a director and owner of a limited company, you are entitled to pay yourself a salary at whatever salary level you like. However, you do need to be aware of the tax implications when making a decision on the amount you wish to pay yourself, and in this blog we review the options available to you to ensure you are working as tax efficiently as possible.
You will be aware of the tax benefits of a limited company structure, including the opportunity to reduce your corporation tax bill by paying yourself a salary and/or dividends. Another significant advantage of paying yourself a salary is that if you do so at the Lower Earnings Limit currently set at £6,136 for the 2019/20 tax year, you will be entitled towards a state pension at retirement. This low level of salary therefore is a good starting point when deciding the level of salary that works best for you.
How much salary should I take?
All taxpayers in the UK have a personal allowance of £12,500 in the 2019/20 current tax year so this amount of earnings is completely tax free. However, if you do use your entire personal allowance, there are National Insurance Contributions (NICs) implications.
NICs are only payable once you reach a certain salary threshold known as the NIC Primary Threshold, which is set at £8,632 for the current tax year.
This means that if pay yourself a salary starting from the Lower Earnings Limit as noted above of £6,136 but do not pay yourself more than the NIC Primary Threshold of £8,632 per annum, you do not need to pay NICs but you are still eligible for the state pension. As you may already be aware, the state pension is funded through a portion of NIC payments by UK taxpayers, so being able to set your salary within these parameters means a double benefit to you – no NIC contributions and yet you retain your state pension contribution record. In the UK, you are required to work thirty years to be eligible for the state pension when you retire. The current retirement age is set at 66 for both men and women.
If you are taking a salary from your limited company, this salary payment will be subject to income tax just as any other employee of a business, through Pay-As-You-Earn (PAYE). You will therefore need to ensure that the income tax you pay does not outweigh the corporation tax reduction advantages you will receive as a result of paying yourself a salary. As noted above, you do however have an annual personal allowance to use which is tax free, which is £12,500 for the current tax year.
Too good to be true?
There are, however, other disadvantages to consider when paying yourself a low salary such as the level of the Lower Earnings Limit. These include:
- If you pay yourself at the NIC Primary threshold, you will not be utilising your full tax-free personal allowance. However, you could mitigate this by paying yourself dividends
- You could receive reduced cover with any insurance policies you take out for critical illness or personal accident for example, as these are based on your earnings
- Similarly, if you want to apply for a loan or mortgage, you may have issues if your salary is too low, although as a self-employed person you should be able to work around this with a specialist mortgage broker providing insight on your company’s earnings
- Maternity benefits could be an issue as you only qualify if you are considered employed and meet the National Minimum Wage (see below)
- National Minimum Wage Regulations dictate that you are only subject to the regulation if you hold a contract of employment, and so ‘office holders’ like directors of a limited company would not be included in the rules. Therefore, advantages like maternity benefits, you would not be entitled to.
Top up with dividend payments
When your limited company is in the black and you have profits to report at the end of the tax year, you have a decision to make on how to use your profits, either reinvesting back in the business or paying yourself dividends. Dividends are paid out to shareholders of a company, which include the owner(s) of the limited company and so are an additional source of income from your business on top of your salary.
Paying yourself a salary up to the National Insurance Primary threshold of £8,362, you are not subject to income tax or NICs (as long as these are your only earnings) as you are below the annual personal allowance threshold of £12,500 for the current tax year 2019/20, and we would recommend this as the most tax efficient way to extract money from your business.
You also have the option, as the owner of the limited company, and if your business is profitable, to extract further funds from your business via dividend payments and can do so tax free at £2,000 per annum. So in total, you can extract £10,362 without incurring any tax or NIC and keep your pension contribution record active.
Of course as a director and owner of your limited company, you are able to pay yourself any level of salary you wish, and if you wish to pay yourself a higher salary, we would be able to offer you advice on how to do this most tax efficiently.
Written by Shaima Todd