One of the main reasons to set up your own company is to reduce your liability for tax. But how does this work and how much should you pay yourself?
There’s no standard amount to set as your salary, and it’s well worth seeking advice on what works best for you. But generally, most limited company directors choose to pay themselves a low salary topped up with dividends.
Your salary is an ‘allowable business expense’, which reduces how much Corporation Tax your company pays.
What to consider in setting your personal salary
1. State pension access
If you set a salary at above the Lower Earnings Limit you will continue to qualify for your state pension. The Lower Earnings Limit this tax year is £6,396.
2. Minimum wage
As a company director, you’re not subject to the National Minimum Wage unless you have a contract of employment in place.
3. Income Tax
Income up to the Personal Allowance is free from Income Tax. This threshold is currently £12,570.
4. National Insurance
If your salary is above the National Insurance (NI) ‘Lower Earnings Limit’ (£6,396) but below the NI ‘Primary Threshold’ (£9,880 per year), you won’t pay NI contributions as an employee, but you do retain your State Pension contribution record.
If you take a salary of more than £9,100 (the NI ‘Secondary Threshold’), your limited company will have to pay National Insurance contributions.
What’s the general approach to setting a salary?
Many company Directors choose a salary that is above the Lower Earnings Limit – so they qualify for the state pension – but below the level where they need to pay either employee or employer’s NI. Currently, that means a salary of £9,100.
Topping up your income with dividends
Once you have set your salary at a certain level, you can add to this by taking dividends – a share of the company’s profits.
You can take all your annual profits as dividends, just a proportion, or none of them. Your company can retain profits over the years and distribute them as and when you (and any other shareholders) wish.
There are three main benefits of taking dividends:
- They attract lower rates of income tax than salary
- National Insurance Contributions are not payable on dividends (neither employer’s nor employee’s)
- There is a tax-free dividend allowance on top of your personal allowance. In 2022/23 this is £2,000 – so you can earn up to £12,570 without paying tax.
An important thing to be aware of is that you can only take dividends when the company has turned a profit. If you take dividends over the level of your profit, the difference is seen as a Directors Loan.
Income tax vs Corporation Tax
A limited company is a very tax efficient businesses structure because limited companies pay corporation tax on their profits of a flat rate of 19%. Meanwhile a sole trader will have to pay Income Tax on all taxable earnings, at a rate of 20% if they are a lower rate taxpayer, or 45% if they are charged at the higher rate.
Sole traders cannot minimise their tax or National Insurance liabilities, or defer tax by leaving profits in the business to withdraw later.
Example
The following example is based on a company making a profit of £40,000 in the tax year. The Limited Company Director takes a salary of £9,100 and tops their earnings up via dividends.
| Sole Trader | Limited Company | |
| Profit | £40,000 | £40,000 |
| National Insurance Class 2 | £156 | £0 |
| National Insurance Class 4 | £2,823 | £0 |
| Income Tax | £5,500 | £0 |
| Corporation Tax | £0 | £5,959 |
| Dividend Tax | £0 | £1,465 |
| TOTAL after tax | £31,520 | £32,574 |
Generally, a Limited Company Director is slightly better off from a tax position than a sole trader. Also, a limited company enjoys more business expenses that can be deducted from profits before tax.
On the other hand, there are various responsibilities that Limited Companies must meet, such as filing statements, creating formal accounts and managing other paperwork. Most limited companies choose to appoint an accountant to manage this for them.
We work with limited companies and sole traders to provide tax advice, company accounting and payroll services. Get in touch with us today