UNDER REVIEW FOLLOWING THE CHANCELLORS SPRING STATEMENT
When you are trading through your own limited company, you can optimise how you pay yourself via salary and dividends to be tax efficient. This is normally achieved by paying a small salary to secure pension entitlement, and taking the remainder via dividends.
Preserving pension entitlement
One of the main advantages of paying a small salary is to ensure that the year remains a qualifying year for state pension and contributory benefit purposes. To qualify for a full state pension on retirement, an individual needs 35 qualifying years.
For the year to be a qualifying year, earnings must be at least equal to the lower earnings limit. A director has an annual earnings limit, and for 2022/23, the annual lower earnings limit is set at £6,396. Where the shareholder is not a director, earnings for each earnings period must be at least equal to the lower earnings limit. For 2022/23, the weekly and monthly thresholds are, respectively, £123 and £533.
Contributions are payable by the employee at a notional zero rate on earnings between the lower earnings limit and the primary thresholds. The employee starts paying contributions once earnings exceed the primary threshold.
Optimal salary – Employment allowance is not available
The employment allowance is not available to companies where the sole employee is also a director. This means that personal companies will generally be unable to claim the allowance.
For 2022/23, the primary threshold is set at £9,880 (£190 per week, £823 per month) and the secondary threshold is set at £9,100 (£175 per week, £758 per month).
Although the maximum salary that can be paid without paying any National Insurance is one equal to the secondary threshold of £9,100 for 2022/23, it is beneficial to pay a higher salary equal to the primary threshold of £9,880. Employer’s National Insurance will be payable on the salary to the extent that it exceeds £9,100 at a cost of £117.39 (15.05% (£9,880 - £9,100)), however, this is outweighed by the corporation tax deduction at 19% on the additional salary and the employer’s National Insurance.
Once the primary threshold is reached, employee contributions are payable at 13.25%. At this point, the combined National Insurance cost of 28.3% (15.05% + 13.25%) is more than the corporation tax saving and paying a salary in excess of the primary threshold is not worthwhile.
Thus, where the employment allowance is not available, the optimal salary is equal to the primary threshold for 2022/23 of £9,880 (£190 per week, £823 per month).
Optimal salary - Employment allowance is available
In a family company scenario, the employment allowance will generally be available if there is more than one employee on the payroll. As long as the employment allowance is available to shelter the employer’s National Insurance that would otherwise arise, the optimal salary is one equal to the personal allowance, set at £12,570 for 2022/23.
No National Insurance is payable until the primary threshold is reached. Above this level, employee National Insurance is payable at the rate of 13.25%. However, the additional salary saves corporation tax at 19%. Once the personal allowance has been used, tax at 20% is payable as well as employee’s National Insurance of 13.25%, which exceeds the corporation tax deduction of 19%.
Thus, where the employment allowance is available, the optimal salary for 2022/23 is one equal to the personal allowance of £12,570 (£242 per week, £1,048 per month). Note though that the tax saving between a salary of £12,570 and £9,880 is minimal, so if you are at all unsure as to the entitlement to the employment allowance, you might be better advised to stick with a salary of £9,880.
Note: the above assumes that the personal allowance remains available and does not consider any other income streams. If in doubt, please seek advice.
The information contained within in this article is provided for informational purposes only and is not intended to substitute for obtaining accounting, tax, or financial advice specific to your own circumstances from your own adviser.