Tax Efficient Remuneration: What’s the Most Tax-Efficient Directors’ Salary for 2022/23?
The conversation around the most tax-efficient method of paying Director’s is a perennial one. What salary should they be paid? How much dividends should they declare? And what is the best mix of the two?
It can be a bit of a minefield: packed with confusing terminology, percentages and tables of figures that can be intimidating for business owners and agencies in the process of scaling up.
We’re here to help. This blog will demystify the subject of Directors’ salaries and reveal how our expert accountancy team can help identify the most tax-efficient solution for you.
Why pay yourself a Director’s salary?
So, how do you define a Director?
A company Director is an office-holder, which means that they have a legal status and set responsibilities. This means that as a Director, they are legally responsible for the company’s business and can be held accountable for its actions.
Not every Limited Company pays their Directors a salary, though in some cases it’s a legal requirement, thanks to either a Shareholders’ Agreement or Articles of Association.
There are, of course, many advantages in Directors’ paying themselves a salary, including:
- to build up qualifying years towards the state pension
- to increase personal pension contributions
- to retain maternity benefits
- to reduce corporation tax
- to obtain/pay a salary even when there are no profits
Limited Company Directors are technically both employers and employees. Like every salaried member of staff, they must pay National Insurance Contributions but no such levy applies to dividends.
Directors’ National Insurance Contributions
National Insurance Contribution rates change regularly as part of the annual budget process. In recent years these changes have happened more often than just once a year.
Directors’ Class 1 National Insurance thresholds for the 2022-23 tax year are £11,908, while the secondary threshold stands at £9,100 per year.
Companies can also apply for the Employment Allowance, which applies only to employer contributions toward National Insurance, and provide up to £5,000 per year in tax relief.
Businesses or agencies must have at least one employee and have less than £100,000 in National Insurance liabilities from the previous year to be eligible for the Allowance.
Income tax thresholds
The UK standard Personal Allowance in the 2022/23 tax year – the annual gross salary amount you can earn before you pay income tax – is £12,570.
This earnings limit applies to almost every salaried worker, with exceptions including people who earn more than £100,000 or those claiming Marriage Allowance or Blind Person’s Allowance.
Directors’ salaries are among a wide range of allowable expenses that are tax deductible. But taking a company salary isn’t the only remuneration strategy open to company Directors.
Directors and dividends
Dividends can be declared from retained profits. Retained profits are those that are left in the business over after all expenses, taxes (e.g. corporation tax) and previous dividends have been deducted.
Some company Directors use these funds as a means of payment, because they’re not subject to National Insurance contributions.
In addition to the tax free personal allowance, there is a further dividend allowance which means the first £2,000 of dividends that a person receives is tax free. This allowance will reduce to £1,000.
Dividend payments above that threshold are subject to the three bands of income tax:
- the basic rate of £12,571 to £50,270 or 20%
- a higher rate of £50,271 to £150,000 or 40%
- and the additional rate at over £150,000 or 45%.
A Directors remuneration is usually made up of a basic salary plus a dividend and both their own tax implications. It’s important to note that at time of writing, these bands are due to change for the 2023/24 tax year. Notably, the additional rate band will reduce from £150,000 to £125,140.
The drawbacks of dividends
On the face of it, there are many benefits to paying a Director in dividends, but there are a few pitfalls too.
First and foremost, you can only pay dividends out of retained profits, and relying on them too heavily could result in an unpredictable income.
They also don’t count as relevant UK earnings for tax relief on personal pension contributions. We can help put in place a remuneration strategy to bolster your retirement plans if you need more support in this area.
If you accidentally take a dividend not covered by profits, it’s regarded as a Director’s loan. This must be repaid within 9 months of the firm’s financial year to avoid an additional corporation tax charge for the company. .
How to determine the most tax efficient Directors’ salary
We can now start to work out the optimum salary for the Director of their own Limited Company or agency, based on the information we have so far.
The tax-free allowance enables a company Director to pay themselves up to £12,570, while the tax-free dividend allowance in the 2022/23 tax year is £2,000.
Let’s examine how both the personal allowance and the dividend allowance combine to impact the salaries of both sole and multiple Director companies.
The sole Director
For a sole Director with no other income paying themselves a salary through their own Limited Company, the most tax efficient annual payment amount for the 2022/23 period is usually £9,100 or £758.33 per month. This is because:
This salary is lower than the primary threshold for National Insurance, and at the secondary limit, so you won’t need to pay employee’s contributions.
The figure is higher than the Lower Earnings Limit of £6,396 but below £12,570, so the sole Director will still earn National Insurance credits, enabling them to accrue qualifying years for their State Pension.
The salary is also below the tax-free Personal Allowance threshold. However, a sole Director cannot claim the Employment Allowance as the eligibility criteria demand a minimum of two Directors.
Two or more Directors
The most tax efficient salary for two or more Directors for the 2022/23 is £11,908 per year or £992 a month.
This is because two or more Directors can draw an annual salary that meets the primary threshold without paying employee’s National Insurance. Don’t forget the salary will also be offset against corporation tax.
Unlike the sole Director, they can then claim the £5,000 Employment Allowance to cover their employer’s National Insurance contributions.
A word about Child Benefit
When calculating the most tax efficient salary for Directors, it’s worth keeping Child Benefit payments in mind.
Directors who receive child benefit must ensure their total income does not exceed £50,000. If this is the case, they could be subject to High Income Child Benefit Charge.
Other sources of income
When calculating the most tax efficient salary, it’s worth remembering not every company Director has a single source of income.
If they are receiving payments from elsewhere that account for the £12,570 Personal Allowance, then income on top of that is subject to the usual tax and National Insurance levies.
Achieving a tax efficient salary: an example
Deborah is the sole Director of a Limited Company with no other income. She is considering the following payment choices:
- drawing no salary: the hassle of running a payroll is not worth the tax saving
- drawing a salary to maximise her full tax-free allowance.
Neither of Deborah’s options are the most tax efficient ways to pay herself. In fact they’re the opposite.
By not paying herself a small salary she misses out on the part of her salary that would incur no National Insurance or income tax. At the same time she doesn’t benefit from the corporation tax saving the company would make on that small salary.
If she decides to pay herself a market wage, then Deborah faces a large and unnecessary tax and National Insurance bill that must be paid to HMRC.
If she chooses to pay herself a monthly salary but doesn’t run it through payroll or declare a dividend, the payments are seen as Directors loan payments that must be either repaid or set off against a dividend or salary later.
Let’s contrast Deborah’s personal circumstances with Jeremy, a sole Director who is paid via a combination of salary and dividends. He has no other income or tax reliefs available to him.
Jeremy pays himself a salary of £11,908 and takes dividends of £38,363 from the company. The salary is tax and National Insurance free as it is below both the income tax personal allowance and the primary threshold for National Insurance.
The first £662 of his dividends are tax free as they are covered by the remainder of the £12,570 Personal Allowance that has not already been used by the £11,908 salary. The next £2,000 of dividends are covered by the £2,000 tax free dividend allowance.
He has earned £14,570 completely tax free. The next tranche of dividends, worth £35,700, face dividend tax rates of 8.75%, taking him to the top level of the basic income tax rate.
Jeremy will pay personal tax of £3,124 on his annual salary and dividends of £50,270: effectively a tax rate of just over 6%.
Helping Directors of scaling agencies
We understand that numbers can be intimidating, especially when you’re focused on growing your business.
Figuring out the most tax efficient way to pay yourself as a Director or how you claim relief may not even be among your first priorities. That’s where our team comes in.
We can identify the most effective salary to pay yourself that will reduce your corporation tax bill, ultilise your dividend allowance and ensure you qualify for state pension when the time comes.
Drawing on our deep knowledge of Xero, our team can put in place systems and processes that will not only ensure tax efficient Director’s salary payments, they will also help identify other ways your agency can maximise its financial performance.
Whether you’re a newly appointed Director unsure about what or how to pay yourself or you’re an established agency head looking to optimise any corporation tax saving, we can help.
Our expert team will ease any concerns and identify opportunities. Drop us a line using this contact form, and we’ll get back to you straight away.