For owner-managed companies, the combination of salary and dividends as a way of remunerating themselves is a key tax-efficiency process, and getting that mix right can bring benefits to those owners.
When making decisions on salaries, it is an important consideration that it is possible to draw a salary of up to £8,632 for the tax year and earn a credit towards state pension on retirement. This equates to a monthly salary of just under £720, which attracts no Income tax or National insurance contributions, but earns the tax payer the credit towards state pension entitlement, for this tax year.
Whilst it is significant to consider contributions towards state pension, it is also beneficial to remember they are also deductible for Corporation tax purposes. The company will benefit from tax relief for payments made as salary and wages, however this is not applicable to dividends.
The payment of dividends is however, also deemed as beneficial in addition to the basic salary mentioned above, as they are taxed relatively lightly when they fall in the basic rate tax band (7.5% tax rate, compared to 20% Income tax on salary) and are also free of NIC’s. So despite the fact that no relief for Corporation tax is achieved with the payment of dividends, they still offer a significant tax advantage over paying salary at the basic rate tax level.
In the higher rate tax bracket, dividends still attract a lower rate of tax than salaries (32.5% tax rate compared to the 40% tax rate levied on salaries), but the difference in tax rates (and hence the benefit) is reduced.
So for a one-owner managed Limited company, the recommended salary each month is just under £720 (£719.33 to be precise!) with the remainder being drawn as dividends in order to minimise the Income Tax and National Insurance contributions.
As usual with tax, there can always be complications such as the High Income Child benefit clawback to consider and the amount of reserves available for distribution as dividends, and so if you are unsure about the best remuneration for your Limited Company, please feel free to get in touch.