In the corporate world, a limited company is treated as an entirely separate legal entity from its owners and from the directors responsible to run the company. That means the director or the owner will have a separate income tax assessment and the company will have its own corporation tax assessment.
That being said, a director cannot just take money out of the company in the form of drawings and has to either pay himself a fixed salary or income in the dividend form. Here is what you need to do in order to establish a tax-efficient director’s remuneration system.
Tax-Efficient Combination of Director’s Salary and Dividend for Tax Year 2022/23
Like every other taxpayer, directors of limited companies are also bound to give tax on their income, regardless of whether it is in the form of salary or dividend.
Before we jump into the details of structuring a director’s remuneration system that reduces your tax bill, let’s explore the available allowances first.
Before jumping into the specific rules of salary or dividend tax 2022-2023, let’s first discuss the general criteria:
- Every individual will receive a tax-free personal allowance of £12,570.
- The threshold for basic rate taxpayers will remain at £50,270.
- On dividend incomes, the tax-free allowance will remain at £2000.
- The dividend tax rates have been increased by 1.25% for the tax year 2022/23. This will apply to all UK taxpayers.
The 2022-2023 Dividend Tax Rate Threshold
|THRESHOLD||DIVIDEND TAX RATE|
|BASIC RATE TAXPAYER||£12,570-£50,270||8.75% charge but on the dividends above the allowance for dividend which is £2,000|
|HIGHER RATE TAXPAYER||£50,271-£150,000||33.75%|
|ADDITIONAL RATE TAXPAYER||More than £150,000||39.35%|
In the UK tax system, every taxpayer can have a tax-free income of up to £12,570, known as the personal allowance. In addition, there’s a dividend allowance of £2,000 available to individuals with dividend income. That means you can legally earn £14,570 as a director each year without paying any tax.
Pros of having a Combination of Salary and Dividend 2022-2023
If you are a director of a limited company and acquire shares of the company, you are the director as well as the owner of the company. Following are the ways through which income becomes tax efficient for you:
- Less salary and more dividend: it is beneficial as dividend income has no liability of national insurance contribution.
- Director’s salary: paying salary to the director will be shown as an expense in the income statement which will reduce taxable income. It can also be claimed as a tax deduction.
- It is not necessary to distribute all the post-tax income as a dividend, the company has the option to retain it, in this way it can claim business asset disposal relief on the closing of the company.
In order to determine the best combination of dividends and salary for 2022/23, you’ll need to consider the current national insurance thresholds. These are as follows:
National Insurance Contribution on Director’s Salary
|Lower earnings limit||The lower-earning limit is £533 per month or £6396 per Anum according to the tax year 2022/2023. If you are paying a salary above this limit, you can keep the entitlement to start a pension and state benefits.|
|Primary threshold||From July 6. 2022 the primary threshold is £1,047.50 per month and £11,908 per annum, when a taxpayer will exceed this limit it automatically becomes liable to the employee’s national insurance.|
|Secondary threshold||The secondary threshold limit is £758 per month or £9,100 per annum, when this level is exceeded by the company, the company will start paying the employer’s national insurance.|
Suppose that your company has a taxable income of £50,270 for the tax year 2022/23 and being the director, you are curious as to how to pay yourself in a tax-efficient manner. There are 2 options below
Best Combination of dividends and salary for 2022-23
Option A- The Personal Allowance Limit
If you are eligible for an employment allowance which is now £5000 and did not fully utilize it against your existing employee’ salaries, you can pay the director’s salary up to the personal allowance limit which is £12,570. So, the directors plus owners are advised to pay themselves a salary up to the personal allowance limit, and the rest of the money, they should take as dividend income. This might be the case if you and your spouse work full-time in the business or you have other employees
If you have a surplus employment allowance, we’d recommend you pay yourself a salary up to the personal allowance of £12,570. You can then take the rest as dividends of up to £37,700 without paying a higher rate tax.
Adopting this strategy results in £3,211 basic rate tax and Employee’s national insurance to pay. You can see how this is calculated below:
- Employer’s National Insurance – £522.23 (being £12,570 less Secondary Threshold £9,100 = £3,470 *15.05%). However, in this example, we’re assuming that this is covered by the employment allowance
- Personal allowance – £12,570 fully utilised against the salary
- No tax for the first £2,000 dividends due to the dividend allowance
- £35,700 (£37,700 less £2,000) dividends taxed at 8.75% – £3,123.75
- Employee’s national insurance payable on salary – £88 (£12,570 less £11,908 = £662 * 13.25% (assuming NI letter = A)
Choosing this option means you’ll have net cash of £47,058 (£50,270 less £3,124and £88) in your pocket after tax.
Your company will also have a corporation tax saving of £2,388 (£12,570 * 19%) with this strategy.
Option B- Employer National Insurance Limit
Other than above option A, this scheme advises the director to pay himself a salary up to the limit of the employer’s national insurance contribution threshold of £758 a month or £9096 per annum. This is less than the employee’s national insurance contribution limit. Directors should get the rest of the income in the form of dividends. This option is preferable if you are one director company
At this level of dividends, you will have a basic rate tax to pay of £3,124 calculated as follows:
- No tax up to the personal allowance of £12,570 (£9,096 of which is salary) and the balance of £3,474 for dividends
- There will be no tax payable on dividends of £2,000 as this is covered by the dividend allowance
- £35,700 (£41,174 less £3,474 less £2,000) dividends taxable at 8.75% – £3,124
The net cash you’ll receive is £47,147 (£50,270 less £3,123) in your pocket after tax.
Your company will save a corporation tax of £1,728 (£9,096 * 19%) with this strategy.
Answer Best combination of dividends and salary for 2022/23
Considering the savings of both corporation tax and personal tax savings, Option A is preferable. It will result in savings of £573 more than Option B. However if you are one director company, Option B is still preferred as you are not eligible for Employment Allowance.