As a director and/or shareholder of a limited company, it can often be more tax efficient to take your own income as a mixture of salary and dividends.
However, if you haven’t done this before, or if you are struggling to get your head around the theory, the process can quickly become confusing.
Directors vs shareholders
A director of a limited company is the person(s) that runs the company. A shareholder of a limited company is the person(s) that owns the company. This can often be the same person(s).
A director can be paid a salary from the company through PAYE, while shareholders are paid with dividends.
Dividends are profits (after corporation tax) which are distributed to the shareholders according to the percentage they own in the company.
Sole director or shareholder
If you are the sole director and shareholder of a limited company, often the most tax efficient way for you to receive income is to take a small salary up to the National Insurance (NI) threshold with the remainder taken as a dividend.
The salary that you process will be an expense to the limited company (and therefore reduce corporation tax) but it will be tax and NI free to you personally. If this is your sole source of income, this is a great way to utilise your allowances.
Dividends are tax free up to the first £2,000 then 7.5% up to the higher rate threshold. Anything above the higher rate threshold is taxed at 32.5%, so it’s best to avoid this if possible!
If you’re financially savvy, you may be wondering why it’s best to take a salary up to the NI threshold (£9,568 in 2021/22) rather than the Personal Allowance threshold ( £12,570 in 2021/22).
The reason for this is that as a sole director you are not entitled to the employer’s NI allowance, meaning that you would pay 12% employee’s NI and 13.8% employer’s NI on your income above the NI threshold, which is more than you save in corporation tax.
More than one director or shareholder
If you’re running a company with an equal business partner or spouse then the same arrangement can be applied to them so that each of you receives a tax efficient sum.
An additional director means your company (as long as it’s not a connected company) is eligible for employer’s NI allowance.
Therefore the directors can run a salary up to the Personal Allowance threshold rather than the NI threshold and save more tax as a result. There will be some employee’s NI to pay but this is just 12% with the additional salary being offset against 19% corporation tax.
However, it’s important to note that if you have multiple directors and shareholders with different ownership percentages the above arrangements will most likely not be feasible.
In this instance, it’s usually better to pay the directors a full salary in relation to the work they carry out and for the shareholders to receive dividends at agreed intervals in time. Although not as tax efficient, everyone is then paid fairly.
If you have other income
If you have other income during a tax year then running a director’s salary may not be the most tax efficient option for you. There are a few actions you might consider.
If other income is then below the thresholds, the difference can be calculated and put through as salary so all allowances are used.
If your income is over the threshold then you might take a salary at the NI threshold, which would need to be reported through PAYE. Or, you may be able to take a director’s salary which is below the NI Lower Earnings Limit.
If you’re unsure of the best option, then we strongly recommend that you speak to your accountant for a full review.
I don't pay any NI, what about my pensions contributions?
As long as payroll is being run for you and it’s over the lower threshold, then deemed NI contributions are made on your behalf which counts towards your state pension and other benefits.
Salary less than minimum wage
The minimum wage only applies to employees and does not affect directors. As a director of a
company, you can pay yourself as little or as much as you like without having to worry about this.
If you have any further questions regarding salary and dividends simply phone 020 3355 4047 and one of our friendly advisors will be happy to help.