Tax Efficient Director’s Salary – The Ultimate Guide
So, you’re a Director of your own company. This means you are legally a separate entity from your Limited Company even if you own the Company. This is often very confusing and “fries your brain”, BUT it is a tax efficient way of taking money. As a Sole Trader you simply keep the profits of your business. This is not the case when you’re a Director of a Limited Company.
As a Director, you will need to choose how much to pay yourself. In this article, we show you the most tax-efficient way of taking an income from your own Limited Company.
Firstly, it is best to pay yourself in two ways – become employed by your own company taking a low salary and also take dividends.
Use Dividends and a Salary
You are a Director of your own company and we suggest to be tax efficient you should be an employee of your own Limited Company. Employers and Employees both pay National Insurance Contributions (NICs) on salary payments, but not on dividends, so it makes sense to pay yourself a smaller salary and make up for it with dividend payments.
Due to being “office holders” you do not need to comply with the minimum wage rule. So, the burning question is how much should you pay yourself from your own Company? This is purely a balancing act in order to be as tax efficient as possible.
In order to get it right we need to look at how many people there are in the business, tax allowances for dividends, tax relief for Employee salaries, and even the benefits of making qualifying payments for the State Pension.
So there we have it! Read on to find out the best way to pay yourself.
The rates are different between Employer’s NI and Employee’s NI. What we don’t want is the business paying Employer’s NI. However, if you have more than 1 Director, you can claim the Employer’s allowance of £4,000 pa which will cover Employer’s NI if we keep the salary within the correct parameters. As a Sole Director, you cannot claim the Employers allowance. Therefore, there is a difference in how much you can take between a business with 1 Director, and business with 2 plus Directors.
The 2022/23 NI thresholds for Employers and Employees are shown in our table below. The threshold for Employers is actually lower, so they start paying NI sooner than Employees.
Differing Levels of NI Contributions
|Weekly NI Threshold||Monthly NI Threshold||Annual NI Threshold|
Lower Earning Limit (LEL): Employers who earn below the limit don’t incur NI, but they also don’t accrue NI benefits, such as qualifying payments toward the State Pension
Primary Threshold: This is the point at which Employees start paying NI. Any earnings below this point but above LEL still do not incur NI, but Employees will earn NI ‘credits’ and accrue NI benefits.
Secondary Threshold: Employers make National Insurance Contributions on salary payments above this threshold.
If you take a salary higher than the Lower Earnings Limit (£6,396 per year in 2022/23) as an Employee you will build up qualifying years for your State Pension.
If your salary is above the LEL but below the Primary Threshold (£9,880) then you’ll accrue all the benefits of NI, without actually paying it. This will affect how much State Pension you are entitled to once you pass state retirement age.
Director’s Salary & Tax Free Personal Allowance
Your Personal Allowance is the amount you are allowed to earn before you have to start paying income tax.
In 2022/23, the Personal Allowance is £12,570.
You only pay tax on the part of your income that is above the Personal Allowance threshold. For instance, if you earn £16,000 in a year, you’ll only pay income tax on £3,430.
£16,000 (salary) – £12,570 (tax free Personal Allowance) = £3,430. The amount subject to income tax is £3,430.
Firstly, when you take dividends, you have an additional tax-free amount of £2,000 increasing your tax-free allowance for 22/23 to £14,570. Dividends are subject to tax which is increasing from 7.5% in 21/22 to 8.75% in 22/23.
Salaries and Corporation Tax
The Corporation tax that a limited company is subject to is paid on the profits of the business. As salaries are a direct expense to the company, putting yourself on the payroll will reduce your profits, thereby reducing your Corporation Tax.
So having considered all the above, the most tax-efficient salary for a Limited Company Director depends on whether they’re a Sole Director, or run a business with 2 plus Directors.
If you’re a Sole Director the best salary to put through the business for the tax year 22/23 is £9,100. The company will not pay Employer’s NI. You also as an Employee will not pay NI, however as it above the Lower Earnings Limited, you will earn NI credits.
To be eligible to claim the Employment Allowance (£4000 relief) you must have at least 1 Employee (not a Director) or 2 Directors. In this case you can increase your annual salary to £9,800 without incurring any NI.