Most limited company directors get paid through a combination of salary and dividends. We discuss the two options and how you can combine them for tax efficiency in the 23/24 tax year.
Limited companies are separate legal entities to those who found them, meaning all assets and finances belong to the company rather than an individual or individuals. Unlike a sole trader, a limited company director cannot simply withdraw money from the business.
Related: Sole Trader Or Limited Company – Which Is Best?
Most directors tend to be shareholders too, so they both own the company as a shareholder and run it as a director. This means limited company directors can get paid in two ways – through a salary and in dividends. We discuss each below as well as the options for combining both.
Personal Allowance
Before we get into dividends and salaries it is worth mentioning the personal allowance.
All individuals have a personal tax-free allowance of £12,570 (23/24 tax year) meaning any income under this amount, whether it comes from salary or dividends, is tax-free. For every £2 earned over £100,000 the personal allowance is reduced by £1, so if you earn £125,140 or over your personal allowance is reduced to zero.
Related: Personal UK Tax Rates And Personal Allowances
Paying limited company directors through salary
Directors are able to receive a salary from their company. Just as with employees, this is processed through the PAYE system where any tax and national insurance contributions are taken before your salary is paid.
Company considerations
The company will need to register with HMRC for PAYE and pay Employer National Insurance Contributions (NIC). Employer NIC is 13.8% on any salaries above £9,100 a year (23/24 tax year), which is known as the secondary threshold.
Companies may be eligible to claim the employment allowance. This allows the company to reduce the employer national insurance up to a threshold of £5,000 a year. However, companies with only one employee who is also a director of the company cannot claim this.
Salaries and wages are, however, an allowable expense meaning you can take the expense off your income into account in order to lower the company’s corporation tax bill.
Individual considerations
Salaried employees and directors also pay national insurance (NI). Each employee pays 12% employee NI on any salary income over £12,570 a year (23/24 tax year), which is known as the primary threshold.
As a director, the benefit of taking a salary above £6,396 (the lower earnings limit for 23/24) is that it classes as a qualifying year towards your state pension.
For the 23/24 tax year, any income received above your personal allowance of £12,570 is taxed at the following rates.
- Basic rate: 20% on taxable income up to £50,270
- Higher rate: 40% on taxable income between £50,271-£125,140
- Additional rate: 45% on taxable income above £125,140
Paying limited company directors through dividends
A dividend is a payment to the shareholders of a company from the profits. Limited companies may issue interim dividends (at intervals during the financial year) or final dividends at the end of the financial year. These must be declared and approved at board meetings. Provided a director is a shareholder also then they can be paid through dividends.
Company considerations
Unlike salaries, dividends are paid after corporation tax has been deducted so they do not lower the company tax bill. Dividends can also only be declared and paid from company profit.
Individual considerations
There is a dividend allowance of £1,000 (23/24 tax year), meaning the first £1,000 of dividends received by a company director each year is tax-free. This is in addition to your personal allowance discussed above.
For any dividends received above that figure, the following rates apply for the 23/24 tax year;
- Basic rate: 8.75% up to £50,270
- Higher rate: 33.75% between £50,271 – £125,140
- Additional rate: 39.35% above £125,140
Paying limited company directors best salary and dividend combination
As we mentioned at the start of this article, most limited company directors get paid through a combination of salary and dividends. Generally, the most tax-efficient way tends to be a low salary and the rest from dividends. This is due to the higher income tax rates compared to dividend tax rates. For the 23/24 tax year, there are two optimum approaches.
Taking a salary of £9,100 – simple solution for sole directors
For sole directors with no employees, a common approach is to take a salary of above the lower earnings limit of £6,396 (23/24 tax year) to class as a qualifying year for state pension but not above the secondary threshold at £9,100 to avoid paying employer national insurance.
This is also below the personal allowance of £12,570 making it tax-free plus the salary is allowable for corporation tax which can lower the company tax bill by approx £2,000 (23/24 tax year) depending on your corporation tax rate.
This isn’t as tax efficient as the below option but does reduce the admin and cashflow headache of paying PAYE each quarter.
Taking a salary of £12,570 – optimum salary for many
The option of taking a higher salary of £12,570, which is still below the personal allowance threshold, will further could reduce the company tax bill by approx £760 (23/24 tax year) depending on your tax rate.
Plus, if your company is eligible to claim employment allowance, the employer’s national insurance contribution of £479 (23/24 tax year) can be claimed back.
For sole directors, although there is a further reduction in the corporation tax bill, due to being unable to claim employment allowance means the employer’s national insurance of £479 will be incurred. This still results in an annual saving of around £195.
However, this comes with increased admin and potentially further cashflow management by having to pay PAYE so it might not be worth it for many. This is especially true when you consider that for the individual director to have this saving in their pocket, it will likely be drawn via dividends which will in turn incur tax.
Complimenting salary with dividends
From here the rest is taken in dividends utilising the dividend allowance and the remainder of any available personal allowance. Other elements to take into account are the tax rate increases at both the £50,270 and £125,140 thresholds and also that your personal allowance reduces when income is above £100,000.
The exact combination of salary and dividends will depend on your individual and company circumstances. It is always worth talking to your bookkeeper or accountant to get a full overview of options from which to choose.
Lava Sky Accounting offers bookkeeping and accounting services and packages for Limited Companies. Contact us today to book your free consultation.