January 11, 2019 Optimum Salary and Dividends 2019/20 – Limited Company Directors When you are working through your own limited company one of the key items on your tax planning should be ensuring that you are paying yourself the optimum level of salary and dividends. The advice in this article is geared towards limited company freelancers, contractors and micro businesses with one or two directors / shareholders – at JF Financial these are the kind of clients we specialise in. UPDATE: If you’re looking for advice with regards to the 2020/21 tax year please see our newer article: Optimum Salary and Dividends 2020/21 First, lets go back to basics to understand the differences between a shareholder and a director. The shareholders of a company are those who actually own the company through their holding of shares. The shareholders appoint directors to run the company on their behalf day to day. When it comes to salary and dividends, a salary may be paid to directors for performing their duties as an officer of the company, and a dividend may be paid to shareholders for their share of post tax distributed profits. This article covers the most tax efficient structure of salary and dividends for the 2019/20 tax year (6th April 2019 to 5th April 2020) – if you would like to read our equivalent article for the 2018/19 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 There are other potential tax affecting issues that 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 2019/20? For 2019/20 the personal allowance has increased from £11,850 to £12,500, which means your first £12,500 of income is tax free. Above this the income tax rates are as below (these do not apply to dividends which we discuss after this): £12,500 to £50,000 20% £50,000 to £150,000 40% £150,001 + 45% Scottish resident tax payers have slightly different tax bands for 2019/20, here: £12,500 to £14,549 19% £14,549 to £24,944 20% £24,944 to £43,430 21% £43,430 to £150,000 41% £150,000 + 46% There are further thresholds and tax issues to be aware of but we’ll keep it simple for this article. When it comes to dividend tax rates there are not separate tax rates and bands for Scottish tax payers – the dividends tax rates for 2019/20 for all UK tax payers are as follows: The dividend allowance remains at £2,000 (same as 2018/19) – this means the first £2,000 of your dividend are tax free. Over and above this £2,000, the dividend income is taxed as follows: If you have any un-used personal allowance (£12,500 for 19/20) then that element is tax free Any dividends in the basic tax band (up to £50,000 for 19/20) attract a tax charge of 7.5% Dividends above the basic tax band (over £50,000) are charged at 32.5% Any dividends in the upper tax band (£150,000) are taxed at 38.1%. So if your only income was dividend income you could receive £14,500 of tax free dividend income in 19/20. This is due to both your £12,500 personal allowance and also the £2,000 dividend allowance. Most tax efficient dividend and salary structure for 19/20 For limited company contractors, freelancers and small business owners, taking a low salary with the balance of income being extracted as dividends is a common tax planning strategy. The theory is as follows: 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 2019/20) on the gross salary Any additional amounts you withdraw from your company would be treated as dividends which do not attract national insurance, therefore you are not paying any more national insurance than you need to be 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 not go into the higher tax band (£50,000 for 19/20) so they are 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 extract. Next we discuss the optimum levels of salary and dividends for 19/20. What is the optimum level of salary and dividends for 2019/20? The introduction of the employment allowance in April 2014 enabled employers to not pay the first £2,000 of employers national insurance. This then increased to £3,000 in and remains at that level for 19/20. Typically the employment allowance means that it is slightly more tax efficient to take a gross salary all the way to the tax free personal allowance level (£12,500 for 19/20), however HMRC announced that from 16/17 the employment allowance would not be available to companies where the only person on the payroll is a director, i.e. ‘single director employee’ limited companies. Unfortunately what they have left open as a ‘grey’ area is the situation where, for example, there is a husband and wife who are both directors taking a salary with no other employees. As things stand it would appear this would be ok, however it seems to be that HMRC’s intention is 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). Our stand on this currently is to lean on the cautious side – in the situation of a husband and wife director payroll we would advise only claiming the employment allowance if both parties have an active role in the day to day business. For typical freelancers and contractors we would therefore advise not to claim the employment allowance and go with the simpler option outlined later in this article (Option 2). With this in mind, we have outlined two different salary and dividend options which are put together on the basis that you wish to extract salary and dividends up to the higher tax band (£50,000) but no higher. We have made some key assumptions when preparing these calculations: You are a UK resident You have no student loan balance Your only income is your salary and dividends from your company You are not caught inside of IR35 – see our guidance later in this article You have a standard personal allowance Your company has sufficient post tax profits to support these dividends Option 1 – claiming the employment allowance (if allowed), more tax efficient but a little more admin Take an annual gross salary of £12,500 which is the standard tax free personal allowance for 2019/20. Your personal allowance may be a bit different if HMRC have adjusted your tax code but to keep it simple we’ll assume the standard £12,500. This level of salary will not attract any personal income tax, but it will attract some employees national insurance which will total £464 (rounded). No employers national insurance will need to be paid as it will be covered by the employment allowance, assuming you can claim it. If you have other employees you will need to consider if their salaries already use up the £3,000 employment allowance, if they do then you would be better going for option 2 below. With regards to dividends, the higher tax band is £50,000 so assuming you want to stay in the basic tax band this leaves you with £37,500 of dividends to take (£50,000 less £12,500) There will be some personal tax to pay on these though – the first £2,000 is tax free (dividend allowance) but after that they are charged at 7.5% tax. See below table for illustration: You can see your personal income tax on dividends would be £2,663 and your employees national insurance would be £464, resulting in net cash in pocket of £46,873. Option 2 – take a salary up to the national insurance primary threshold If you can’t claim the employment allowance or want to keep things simpler (we like simple!) this is a good strategy for you. There are two national insurance thresholds you need to be aware of: Lower Earnings Limit – as long as you earn salary above this you are protecting your entitlement to future state pension and benefits, without necessarily paying any national insurance, leading us on to…. Primary Threshold – if you earn above this you have to start paying national insurance So the sweet-spot is to go up to the Primary Threshold but no higher. The national insurance Primary Threshold for 19/20 is £166 per week or £8,632 for the year. Therefore we would suggest a monthly gross salary of £715 which stays just below this threshold and is a nice round amount. With regards to dividends, assuming as with Option 1 you wish to take dividends up to the higher tax band but no further, then you can take slightly more dividends with Option 2 than with Option 1. This is because you are only taking £8,580 of salary which leaves £3,920 of dividends that are in the tax free allowance, as well as the £2,000 tax free dividend allowance. You are not paying any employees national insurance in this scenario which is why you end up with a bit more cash in your own pocket (at the expense of some additional corporation tax for your company). The tax calculation for Option 2 is: Your annual salary is £8,580 so this leaves £3,920 of dividends that can be taken tax free in the personal allowance (£12,500 less £8,580). The next £2,000 of dividends are also tax free as they are within the dividend allowance. This leaves the balance of dividends of £35,500 taxed at 7.5% = £2,663 of tax. See below for how this works out with regards to cash in pocket – it actually works out to be the same tax amount as Option 1. You will note that the net cash in pocket after income tax and employees national insurance is actually slightly higher in Option 2 than Option 1, by £464, however this doesn’t factor in the additional corporation tax you save on the higher gross salary in Option 1 . Comparison of optimum salary and dividends for 2019/20 See below comparison for a table which compares the two options side by side and considers the corporation tax effect as well. For limited company contractors and freelancers, Option 2 (£715 per month salary) is our recommended route – this also has the added benefit of being able to get a bit more cash in your own pocket despite costing a little more corporation tax. Option 2 also is less admin intensive as no national insurance needs paying over to HMRC. IR35 update There have been some sweeping changing to IR35 (employment status) in recent years and there are further changes proposed to come in 2021. If you do not know what IR35 is we would suggest you read our detailed guidance which can be found below: IR35 Changes 2021 In 2017/18 new IR35 rules came in which meant that if you worked in the public sector your end client would tell you if your engagement was inside or outside of IR35 and if it was inside they would deduct tax and national insurance at source before making a payment to your limited company. Before these changes it was down to you as the contractor to judge if IR35 applied or not. It has now been announced that these changes will apply to the private sector also from April 2021, with the finer details still to be worked through. This would mean that the decision as to whether or not an engagement is inside or outside of IR35 will be decided by the end client, not by you as the personal service company contractor / freelancer. This would mean that if an engagement is inside of IR35 your client will deduct tax and national insurance at source. All of our guidance in this article assumes you are operating outside of IR35. Also, please bear in mind that although the tax planning strategy of paying yourself a small salary and then extracting further money from your company as dividends is currently considered relatively low risk, this does not mean that it is risk free from a HMRC challenge. Tax planning ideas 2019/20 Here are some tax planning ideas you might want to consider to help your tax efficiency, these should be discussed with your accountant – if you’re a contractor or freelancer we would advise you to speak with an accountant who specialises in providing accountancy services to the freelancer & contractor sector (like us!). Transfer a minority shareholding to your spouse so they can receive up to £2,000 of dividends tax free Set up a rental agreement with your company for claiming ‘use of home as office’ expenses Company pension contributions (speak to a pension advisor as there are various rules to consider) Also don’t forget about your personal tax payments on account. We hope you have found this article about optimum salary and dividend levels for the 2019/20 tax year useful.