It has been common practice for many small family companies to pay low salaries to the director/ shareholders in order to save national insurance and pay the rest of their required remuneration out in dividends. The national minimum wage legislation doesn’t apply to company directors. They are classed as office holders for national insurance purposes. However, everyone should still receive a salary that is sufficient to qualify for state benefits. For 2014/15, the lowest salary that would still qualify for state benefits is £7,956. Example one shows the effect of continuing what has been typical planning for small family companies. All examples are rounded to the nearest £1 and so may contain immaterial rounding errors. The dividends are chosen to keep the cost to the company the same throughout, so that any tax savings go to the individual directors. All examples assume that there is no other taxable income.
Example One: Company pays director £7,956 salary and £30,000 dividends. Company pays tax at 20%.
Income tax suffered by director is nil as the salary is inside the personal allowance of £10,000 and the dividends (grossed up) plus the salary are within the basic rate band after deducting the personal allowance.
Employees and employers national insurance = nil.
Cash received by the director = £37,956.
Cost to the company = £37,956 less 20% corporation tax relief on the salary = £36,365.
However, the above analysis ignores the fact that there is now a £2,000 employers’ NIC allowance introduced with effect from April 2014. Many small family companies have no employees and so this £2,000 allowance would be available to utilise against the directors’ salaries. This is addressed in example two. The amount of dividends is selected to keep the cost to the company the same as with example one. This way, the tax savings all go to the individual.
Example Two:Company pays director £10,000 salary and £28,365 dividends. Company pays tax at 20%. Company has no employees.
Income tax suffered by director is nil as the salary is inside the personal allowance of £10,000 and the dividends (grossed up) plus the salary are within the basic rate band after deducting the personal allowance.
Employers’ national insurance = nil as it is covered by the new £2,000 allowance.
Employees’ national insurance = £245.
Cash received by the director = £38,120, i.e. an increase of £164 on example one.
Cost to the company = £38,365 less 20% corporation tax relief on the salary = £36,365, i.e. the same as before.
If there are no employees other than several directors, then the above could be repeated seven times. Once there are more than seven directors (or employees) earning £10,000, the £2,000 employers’ NIC allowance will be fully utilised. Therefore in a typical husband and wide type company with no employees, the saving in 2014/15 from applying this strategy would be £328. If there were two children who were also directors, the savings would be £656.
However, if the company has one employee earning £22,500, the £2,000 employers’ NIC allowance is already fully utilised and so the most tax efficient owner/ director’s salary would revert to £7,956. Example three demonstrates this. Again, the dividends have been varied to keep the cost to the company the same so that the individual gets the tax benefit, or in this case to clarify that more tax/NIC is suffered as a result of the salary increase.
Example Three:Company pays director £10,000 salary and £28,139 dividends. Company pays tax at 20%. The company has several employees and the £2,000 employers’ NIC allowance is already utilised.
Income tax suffered by employee is nil as with examples one and two.
Employers’ NIC = £282.
Employees’ national insurance = £245.
Cash received by the director = £37,894, i.e. a decrease £62 from example one.
Cost to the company = £38,139 + employers’ NIC of £282 less corporation tax saved of £2,056 on the salary gross of employers’ NIC, making a net cost of £36,365, i.e. the same as examples one and two.
Other factors to consider
Some directors wish to avoid paying higher rate tax and so take a combination of dividends and salary that keeps them just below the higher rate band. In these situations, if salaries are increased to utilise the new £2,000 employers’ NIC threshold, dividends may need to be reduced accordingly.
Please note that if the company has one employee earning £22,500, the £2,000 employers’ NIC allowance is already fully utilised and so the most tax efficient owner/director’s salary would revert to £7,956. Clearly, thought needs to be given to each company situation.
Summary and Conclusion
Provided the company is paying corporation tax, a salary of £10,000 will be more tax efficient in 2014/15 for directors than a “basic” salary that qualifies for state benefits of £7,956, provided the employers’ NIC £2,000 allowance has not been utilised elsewhere. There is an 8% saving on a salary between £7,956 and £10,000 being 20% corporation tax saved minus 12% employees’ NIC. The savings are £164 per director. This works for the first seven directors after which the employers’ NIC allowance is utilised. Above £10,000, salary becomes less tax efficient than dividends because the income tax personal allowance is exceeded.
Please note that there may be sound non tax reasons for paying higher salaries, such as having sufficient pensionable remuneration and working within the NMW regulations that apply to non directors.
A salary in the £7,956 to £8,000 region isn’t necessarily wrong. A £2,000 bonus could be paid in March 2015 to save cash flow with the employees’ NIC.
