Since the payment of dividends is much more efficient than salary – 7.5% basic rate rather than 20% and no National Insurance (NI) liabilities for either the director nor the company, why should a director even bother with a salary?
Limited companies are subject to paying Corporation Tax, but claiming allowable expenses helps companies to reduce the amount of tax that they have to pay. Director’s salaries are classed as an allowable expense, so paying a director a salary from the business can help lower the company’s corporation tax payments.
By taking a salary, a director is able to build up qualifying years for their State Pension. This will affect how much State Pension they are entitled to, once they pass state retirement age.
Director’s National Insurance contribution
This is known as the Class 1 primary contribution and it is only due on the wages paid through the company. It is not paid on dividends.
It is also important to note that the state pension credit for NI actually kicks in once a director earns £6,240 for the year, which means paying a director between this and £9,500 through the company will entitle the director to state pension credit without triggering any national insurance liability.
The method of calculation is different for a director than an ordinary employee. Directors get all of the NI allowance up front and will not pay NI contributions until their earnings for the year reach the Primary Threshold (PT). This is £9,500 for 2020/21 (£8,632 for 2019/20)
Once their earnings reach the PT they will pay 12% (assuming they are on NI rate A) on all their earnings until they reach the upper earnings limit (UEL). This is £50,000 for 20/21, unchanged from 2019/20.
Once the pay for the year exceeds the UEL the director will continue to pay 2% on all their earnings.
Company’s National Insurance contributions
This is known as the Class 1 secondary contribution and again it is only due on the director’s wages paid through the company where the total for the year is in excess of the Secondary Threshold. £8,788 for 2020/21 (£8,632 in 19/20).
The company will pay a flat rate of 13.8% on the excess.
The employer’s NI liability will be an expense to the company and therefore will reduce profits which in turn will save the company Corporation Tax.
Eligible employers can use the Employment Allowance to claim up to £4,000 in order to cover the costs of employer’s NI contributions.
Employers need to have at least 1 employee or 2 directors on the payroll, and the directors must not have another company that is claiming the Employment Allowance already.
Optimum Salary for a sole director in 2020/21
For a sole director on their limited company’s payroll, the optimum salary in 2020/21 is the secondary threshold of £8,788 per annum.
This is because a sole director cannot claim Employment Allowance, so setting the salary at this rate means the company will not incur employer’s NI.
Optimum Salary for 2 or more directors in 2020/21
If there are 2 or more directors on the payroll, then they are entitled to claim Employment Allowance. This means they can take a salary of £9,500 each, and will not incur any personal NI contributions at all, whilst the company has no employer NI contributions to pay.
However, for a better Corporation Tax saving each director can pay themselves a salary of £12,500, since there is no income tax to pay (as this is the same amount as the personal allowance).
On this level of salary the company will have to pay Employee’s and Employer’s NI of £360 and £512.26 respectively. However, the employer’s NI element is cancelled out by the Employment Allowance, so the only liability is £360 in employee’s NI.
Also, by taking a £12,500 salary, the company saves an additional £570 Corporation Tax that would be due compared to a £9,500 salary (£3,000 * 19%).
SRC-Time are one of the South East’s leading accountancy firms in advising individuals and businesses in all aspects of their accounting and tax affairs and we are able to assist in any issue raised above.
Our expert team is available to provide you with advice and can be contacted on 01273 326 556 or you can drop us an email at email@example.com or speak with an account manager to get any process started.