tax-468440__340.jpgWhat's the best salary/dividend mix for a limited company for 2021/22?

This article covers the most tax efficient structure of salary and dividends for the 2021/22 tax year (6th April 2021 to 5th April 2022) – if you would like to read our equivalent article for the 2020/21 tax year click here.

As always, we would advise that you discuss your specific circumstances with a professional before taking any action.

Here are some key assumptions we have made in this article:

  • You are a UK resident tax payer with a standard personal allowance
  • Your only source of income is your salary and dividends from your limited company
  • You are not affected by IR35

There are other issues  we have not covered in this article, including student loan repayments, child benefit high income tax charge and the withdrawal of the personal allowance once your income exceeds £100,000

How are salary and dividends taxed in 2021/22?

For 2021/22 the personal allowance has increased from £12,500 to £12,570 – this means your first £12,570 of income is tax free.

Also the higher tax band has increased from £50,000 to £50,270

For income above this the tax rates are as below (these do not apply to dividends which we discuss after this):

  • £12,570 to £50,270         20%  
  • £50,270 to £150,000      40%  
  • £150,001 +                        45%

The dividend allowance remains at £2,000 (same as 2020/21) – this means the first £2,000 of your dividends are tax free.

work-2005640__340.jpgOver and above this £2,000, the dividend income is taxed as follows:

  • If you have any un-used personal allowance (£12,570), that element is tax free
  • Any dividends in the basic tax band (up to £50,270) attract a tax charge of 7.5%
  • Dividends above the basic tax band (over £50,270) are charged at 32.5%
  • Any dividends in the upper tax band (£150,000+) are taxed at 38.1%.

For example, if your only income was dividend income, you could receive £14,570 of tax free dividend income in 21/22, although the limited company paying out the dividends must pay corporation tax on any profits, and dividends don't count as expenses for tax purposes.

What's the most tax efficient dividend and salary structure for 21/22?

For limited company business owners, taking a low salary with the balance of income being extracted as dividends is a common tax planning strategy.

This means:

  • Withdraw a low tax efficient salary, no higher than the personal allowance so that it does not attract personal tax
  • Ensure the salary is high enough for national insurance purposes i.e. that it counts as a years ‘stamp’ for your national insurance history to help protect your future entitlement to state pension and other benefits
  • The salary is a tax allowable cost for your business therefore corporation tax is saved at 19% (corporation tax rate for 2021/22) on the gross salary
  • Any additional amounts you withdraw from your company are treated as dividends which do not attract national insurance, therefore you are not paying any unnecessary national insurance
  • Please note that dividends are not a tax allowable expense for your company (unlike a salary) - so your company does not save corporation tax on the dividends

Many people choose to limit their total income to the basic tax band so as not to go into the higher tax band (£50,270 for 21/22), to ensure that their income is not taxed at the higher levels of tax, but this will be a personal choice and a balance will need to be made between tax efficiency and how much of the available profits in your business you want to take in a tax year.

The introduction of the employment allowance allows employers to not pay the first £4,000 of employer's National Insurance, which isoversaw-construction-1730665__340.jpg the level it remains at for the 21/22 tax year.  However, this isn't applicable if the only person on the payroll is a director.  HMRC’s intention is, we understand, to block companies that have no ‘real’ employees from claiming the employment allowance (the government are trying to encourage small businesses to take on employees) – this is clear from the fact that the government have introduced even further restrictions on being able to claim the employment allowance from April 2020.

To keep things straightforward and lean on the cautious side, we advise freelancers and single employee companies not to attempt to claim the employment allowance and go with the simplest option - a monthly salary of £735/month.  The reason for this is given below.

Optimum Directors Salary 2021/22: sole employee

Please note: We have made some key assumptions when preparing these calculations, namely:

  • You are a UK resident
  • You have no student loan balance
  • Your only income is your salary and dividends from your company
  • You have a standard personal allowance
  • Your company has sufficient post tax profits to support these dividends

There are three national insurance thresholds you need to be aware of:

  • Lower Earnings Limit – as long as you pay a salary above this you are protecting your entitlement to future state pension and benefits, without paying any national insurance. For 21/22 this is £520 per month, £6,240 for the year
  • Primary Threshold – if you earn above this you personally have to start paying national insurance – for 21/22 this is £797 per month, £9,568 for the year
  • Secondary Threshold – if you earn above this your business has to start paying national insurance – for 21/22 this is £736 per month, £8,840 for the year

 

You will see that the Secondary Threshold is lower than the Primary Threshold – this means that the optimum level for the purposes of this article is to go up to the Secondary Threshold but not any higher.

Therefore, we suggest a monthly gross salary of £735 which stays just below this threshold and means no national insurance deductions.

Assuming you wish to take dividends up to the higher tax band but no further, then this would leave you with £41,450 of dividend headroom (£50,270 higher tax band – £8,820 salary).

The personal tax on dividends of £41,450 would total £2,678 – this is calculated as below:

  • £3,750 of the dividends are in the tax free personal allowance (£12,570 less £8,820 salary)
  • £2,000 of the dividends are in the tax free dividend allowance
  • This then leaves the balance of dividends totalling £35,700 to be taxed at 7.5% = £2,678

Below we have presented these figures in both monthly and annual amounts:

   Monthly Annually
Salary £735 £8820
Dividends up to £3,454 up to £41,450

Total personal income (before tax)

up to £4,189 up to £50,270
Personal tax to pay up to £223 up to £2,678
Personal income after tax up to £3,966 up to £47,592

 

Please note: in order to pay this level of salary, a payroll scheme must be in place with HMRC and the salary should be reported to HMRC through the payroll system on a monthly basis (known as RTI returns) – Whitehill are able to provide a full payroll service for this..

Optimum Directors Salary 2021/22: 2 or more employees

for those with 2 or more people on the payroll, but overall very modest salaries (so the £4k employment allowance won’t be fully utilised) and preferring tax savings over simplicity, you may choose to opt for a higher salary of £1,047/month . This will incur employee NICs, but still no PAYE as under the personal allowance, and the employment allowance will offset the employer NICs. In practice this will save a couple of hundred pounds over the year, but be aware staff net pay won’t consistently equal their gross pay, so there will be deductions to pay over to HMRC. Please also note this extra £3,000 salary over the year impacts on the dividend thresholds, so basically £2k tax free, £35.7k basic rate (£37.7k total dividends), £49,730 higher rate (£87,430 total dividends). If in doubt, just go for the lower £735/month.