Limited company formation is often considered a prudent choice for self-employed individuals, but it can present many challenges.
One of the distinctions between being paid by an employer and running your own business is the need to determine how your limited company will pay you. Generally, the most tax-efficient way to do this is to take a low salary combined with dividends from your limited company. As a director, you will be given compensation in the same manner as a regular employee. However, you must ensure that you comply with all reporting and tax filing requirements associated with running your payroll in accordance with HMRCs Real-Time Information (RTI) rules, or you could have a risk of incurring fines and penalties. Additionally, you must adhere to HMRCs dividend-issuing rules.
- Reasons for taking a salary from a Limited Company
- Why would I want to take a low salary?
- How National insurance thresholds affect a director’s salary?
- Why might I want to take a higher salary?
- Tax implications of taking a salary
Reasons for taking a salary from a Limited Company
There are two primary reasons to take a salary from a limited company –
- It is considered an allowable business expense, which means that it reduces the amount of Corporation Tax payable by your company.
- If your salary is greater than the Lower Earnings Limit (£6,240 in 2021/22 and 2020/21 tax years – View the latest rates here), you accumulate qualifying years toward your state pension.
Why would I want to take a low salary?
It is worthwhile for a business owner operating through a limited company to consider drawing a low salary as part of their overall remuneration package. If you earn at least £9,568 (the primary national insurance threshold for the 2021/22 tax year), you will still be eligible for national insurance contributions towards your state pension.
As a UK taxpayer, you are entitled to a Personal Allowance each year; any income you receive up to the Personal Allowance is tax-free. A salary of up to £12,570 (assuming no other income except dividends) will be tax-free, although a small amount of national insurance will still be due.
Salaries are a deductible business expense for the company, which means that the limited company will pay less corporation tax.
Additionally, there are National Insurance (NI) thresholds to consider. They are all currently less than the Personal Allowance and should be considered when determining your salary:
The Lower Earnings Limit– As long as your salary exceeds this level, your State Pension contribution record will remain intact.
The primary National Insurance (NI) threshold- As long as your salary is less than this level, you will not be required to pay any employees NIC’s.
The National Insurance (NI) Secondary threshold- As long as your salary is less than this level, your limited company will not be required to pay any employer’s NIC’s.
Thus, the main objective here is to set your salary above the lower earnings limit to qualify for the state pension but below the amount at which you will be required to pay either employee or employer’s NIC.
How National insurance thresholds affect a director’s salary?
National insurance thresholds
Employees are required to pay the following national insurance contributions in 2021/22:
- Class 1 NIC of 12% on salaries ranging between £184 and £967 per week
- 2% NIC on earnings more than the amount of £967 per week
Additionally, employers are required to make NI contributions:
- 13.8 percent class 1 NIC payment on a weekly salary of more than £170 (£8,840 per year).
Employee and employer national insurance contributions are never due on dividends but are always payable on salary.
For the 2021/22 tax year, if your salary is greater than the National Insurance (NI) Lower Earnings Limit but less than the NI Primary Threshold (£9,568 per year), you will not be required to pay employee’s NIC. Still, you will retain your State Pension contribution record. However, your limited company will be required to pay the employer’s National Insurance contributions on any wage above the lower NI Secondary Threshold of £8,840.
For the 2021/22 tax year, we projected that establishing your salary at the NI Primary threshold would require your firm to pay Employers National Insurance and would diminish your companys profits due to the increase in salary costs. Any decrease in the profits of the company affects the amount of dividend available to distribute among the shareholders.
So, we have come to the conclusion that the most efficient tax salary for a director of a limited company (with no other sources of taxable income) for the 2021/22 tax year will usually be £736.66 per month (£8,840 yearly)
Why might I want to take a higher salary?
You might need to face certain disadvantages when your salary is either set very low or you aren’t taking a salary:
- You must be employed and remain compliant with the National Minimum Wage Regulations to be eligible for maternity benefits which could get reduced when you take a low salary.
- Reduced life insurance coverage under health, personal accident, and critical illness as these policies amounts are calculated based on your earnings.
- If your salary is paid at the NIC threshold with no other sources of taxable income, you may miss out on some of your annual tax-free personal allowances.
- Issues with National Minimum Wage Regulations.
- You may have to meet specific eligibility criteria (not sympathetic towards low salary) before applying for a loan or a mortgage.
Tax implications of taking a Salary
All salaries will be taxed under the Pay-as-you-earn system (PAYE) with regular full-time employees. With three distinct PAYE taxes, the benefit of lowering your Corporation Tax burden through a higher salary is quickly overshadowed by the additional tax paid.
Income tax is calculated cumulatively on all your income from employment and other sources of income earned throughout a tax year. For example, if you earn more than £10,000 in a given tax year from any source of income, your tax-free Personal Allowance will be reduced by this amount.
Employee National insurance contributions
Employee National Insurance Contributions (NICs) are not cumulative in comparison to income tax. This means that each new employment has a distinct earnings threshold above which NICs are due. There is a cap of a maximum limit of National Insurance contributions to be paid by employees who are Higher Rate taxpayers.
If you are working as an employee (but not a director), this threshold is set as a monthly limit. If your payment exceeds this monthly amount in any given month, you need to pay NIC’s even if your income is reduced for the rest of the year.
Employer Contributions to National Insurance
Employers NIC’s are calculated in the same way as employee NIC’s are calculated. Employers are required to pay 13.8 percent of an employees wages beyond the weekly National Insurance earnings threshold. This also applies to the salary of your own director and is an additional PAYE tax that the company must pay.
If you pay yourself a salary from your limited company up to the relevant National Insurance threshold, you will not have to pay income tax or national insurance on it as long as it is your sole source of income. Generally, we recommend this choice due to its tax efficiency. However, as said previously, there may be reasons why you choose to give yourself a higher salary.
While you have the option of setting your own salary as a company director, you may wish to seek guidance from one of our specialist accountants to ensure you are paying yourself in the most tax-efficient manner possible.
In case you need specialist advice on "How much should I take as salary from a Limited Company”, kindly call us on 03330886686, or you can also e-mail us at firstname.lastname@example.org
"This article was correct at the date of publication. It is intended for general purposes only and does not constitute legal or professional advice. Independent professional advice should be sought before proceeding with any transaction".