Director

Tax Efficient Directors Salaries Article



An article by Drew Coles member of the Chartered Institute of Management Accountants


What is tax efficient directors salaries?

We are often asked for advice on the most tax efficient way of paying yourself from your company.
The official term is ‘profit extraction’ – how to get more money out of your business and into your pocket – legally of course!
By far the most efficient way of taking money out of your limited company is to pay a combination of minimal Directors Salary plus a dividend and tax free expenses.

Accounting for tax

Basic Directors Salary

The Directors salary should be run through your payroll system to ensure you are deducting the correct amount of PAYE and National Insurance (NICs) on the salary that you are paying yourself.
Salaries attract NICs for both employer and employee. The salary and the NICs are both allowable expenses in the Corporation Tax return.
Employees start paying NICs when earnings exceed the Primary Threshold (PT)
Employers start paying NICs when earnings exceed the Secondary Threshold (ST)
For 2018 - 2019 it is the following:
2018/2019
Primary threshold = £162 per week which is £702 a month and £8,424 year
Secondary threshold = £162 per week which is £702 a month and £8,424 year


What we recommend

We recommend you pay yourself enough to ensure you are slightly over the National Insurance threshold and pay minimum National Insurance contributions to HMRC each month to protect your NI record – by that we mean that you should pay some NICs to ensure you remain eligible for certain benefits including the State Pension.


Dividends

Are paid out of profits after tax or from company reserves – i.e. retained profits after tax has been deducted carried forward from earlier periods.
There is no tax advantage to the company when paying a dividend but salaries are deducted before corporation tax.
Dividends however, are not subject to NICs which makes them more efficient than a salary.
From April 2016, the tax rate on dividends is:
Tax rate on dividends over £2,000
Tax band = Basic rate
7.5%
Tax band = Higher rate
32.5%
Tax Band = Additional rate
38.1%

HMRC Logo

Tax Free Expenses

What can a director pay himself by way of tax-free expenses?
Examples include but are not limited to:
Mileage (but not commuting) for any business-related travel in own car
Use of home office, if the director works from home
Any ‘own pocket’ expenses incurred on behalf of the business
Pension contribution
Childcare vouchers – eligible in certain circumstances

How much to pay?

It does depend on an individual’s personal circumstances, but generally, directors will pay themselves an annual wage equal to or slightly above the primary threshold for NICs.
2018/19 £162 a week, £702 a month and £8424 per year
However…
…in 2014/15 – HMRC introduced the Employers Allowance which allows companies to claim back the first £2000 of Employers NICs. This was great news for employers as this meant that whilst the company was eligible to claim the Employers Allowance – it is more tax efficient for a director to pay himself up to the full tax-free allowance. The director will have to pay approx £204 in the tax year 2015/16 of employees NICs at a rate of 12% (£245 2014/15) but paying NIC’s at 12% is more tax effective than paying corporation tax at 19%.

2015/16 £204 a week, £883 a month or £10,600 a year
2016/17 £213 a week, £916 a month or £11,000 a year
2017/18 £221 a week, £958 a month or £11,500 a year

in 2016/17 – HMRC changed their minds!
HMRC decided to restrict the Employers Allowance to companies that employed more than one member of staff – small companies that have one director/employee are no longer eligible to claim the Employer Allowance which means that most single director/employee companies went back to paying the director an annual wage equal to or slightly above the primary threshold for NICs.
2017/18 £157 a week, £680 a month or £8160 a year

Director salary
Examples

Gary is the director of a limited company, he has no other income (if his tax allowance were utilised elsewhere – i.e a pension or a second job, then we would have to rework our calculations).
He is considering his options:
No salary. He feels that the cost and inconvenience of running a payroll is not worth the tax saving
Taking a salary to the NIC’s threshold to minimise NIC payments
Taking a salary to maximise his full tax-free allowance, (Gary has another member of staff)
Taking a salary to maximise his full tax-free allowance, (Gary has no staff)

Directors salary example
Common errors:
Director doesn’t pay himself at all (it happens!) and doesn’t get the benefit of his tax-free allowance.
Director pays himself a market wage generating a large tax and national insurance bill that must be paid to HMRC and pays large tax or NIC contributions unnecessarily.
Director pays himself a weekly or monthly ‘salary’ but doesn’t actually run it through payroll. If you don’t operate a payroll system then these payments are really directors loan payments that will have to be offset against a dividend later.