When you are a shareholder within a personal and family company there are numerous ways to take money from your business. A popular, and tax-efficient method would be paying yourself a small salary and taking the remainder via dividends. But what would be the optimal salary for you?
The optimal salary will depend on whether the employment allowance is available to protect any Employer’s National Insurance liability.
PRESERVING PENSION ENTITLEMENT
There are many advantages to taking a small salary. One of the main benefits of taking a smaller salary is that that the year remains a qualifying year for National Insurance contributions and the state pension. An individual needs 35 qualifying years to be entitled to the full state pension.
For a year to count as a qualifying year, earnings must be equivalent to at least the lower-earning limit. As a director, there is an annual earning limit. For 2021/22, the annual lower-earning limit is set to £6,240.
For shareholders who are not directors, earnings for each earning period must be equal to at least the lower-earnings limit. For 2021/22, the weekly and monthly thresholds are £120 and £520 respectively.
No contributions are payable by the employee on earnings between the lower-earning limit and the primary threshold. Once the earnings have exceeded the primary threshold, the employee will start to pay contributions.
OPTIMAL SALARY – EMPLOYMENT ALLOWANCE IS NOT AVAILABLE
Generally, personal companies are unable to claim the allowance. If a business has a sole employee, who is also a director, the employment allowance is unavailable.
The primary threshold is set at £9,558 (£184 per week or £797 per month) and the secondary threshold is set at £8,840 (£170 per week, £737 per month) for the year 2021/22.
In 2021/22, the maximum salary that can be paid without attracting any National Insurance is £8,840, which is equal to the secondary threshold. It is advantageous to pay a slightly higher salary that is equal to the primary threshold. Payment for Employers National Insurance at 13.8% is due on the difference between the primary and secondary threshold. This would cost £100.46. However, this is outweighed by the Corporation Tax deduction at 19% on the employer’s NIC and the additional salary.
Employee contributions are payable at 12% once the primary threshold is reached. Once at this point, the percentage for both employers and employees NIC will be 25.8%. This would be more than the current 19% Corporation Tax saving. Therefore, paying an excess over the primary threshold would not be beneficial.
In circumstances where the employment allowance is not available to you, you may want to consider taking a salary equal to the primary threshold for 2021/22.
OPTIMAL SALARY – EMPLOYMENT ALLOWANCE IS AVAILABLE
If there is more than one employee on the payroll within a family company, then the employee allowance would be available.
Where the employment allowance is available, the allowance would shield the employer’s National Insurance liability due. The optimal allowance, in this case, would be the personal tax allowance. This is set at £12,570 for the current year. Once the primary threshold is reached, the 12% employee’s National Insurance is due.
Taking the additional money as salary does save Corporation Tax at 19%. Although, keeping in mind that once the personal allowance has been used up, both personal tax at 20% and the employee’s National Insurance is due. These have a total percentage of 32%, so it may be better to take out any additional money over the threshold as a dividend.
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