Dividends and salary: getting the balance right

If you’re considering setting up your own contracting firm by trading under a Limited Company, then taking a mix of salary and dividends is the most tax-efficient way to take income from the business.

Due to the implications associated with drawing a £Nil salary, many contractors choose to pay themselves a modest salary, topped up with dividends.

For instance, you could pay yourself a basic salary up to the limit of when NI contributions become payable – the threshold for the current 2018/19 tax year is £8,424. Yet, while it’s your decision to do this, remuneration at the NI threshold is lower than the National Minimum Wage.

As of 1 April this year, the National Minimum Wage for people aged 25 and up is £7.83 per hour which, when full-time hours are considered, works out at approximately £14,250 per year. Taking a salary at this level may be a better alternative to taking one below the NI threshold, as it will demonstrate your intention to operate a genuine commercial, contracting business. There is no advantage to withdrawing a salary in excess of this figure however, except in ‘special’ circumstances.

 

Drawing a £Nil salary

So, you may be wondering: Can I take all my income as dividends and not pay myself a salary? The short answer is yes, you can; however, doing this has a number of implications you need to be aware of. These include:

 

The effect on future entitlements

Paying yourself a £Nil salary will mean you do not pay any National Insurance. However, not paying NI contributions could affect your entitlements later down the line, including the state pension and a number of other state benefits.

 

Investigations by HMRC

If you’re not taking any salary from your business, it’s possible that HMRC will argue that the dividends paid or declared incorrectly are in fact ‘salary in disguise.’ In this case, HMRC will seek to tax the dividends as salary.

 

Corporation Tax Relief

Any salary that your company pays to you will qualify for Corporation Tax relief. This means that if your company pays you £8,424 it will save £1,600 in Corporation Tax.

This combined with the fact that this income is tax free for you, as it’s within your personal allowance, makes a nominal salary very tax efficient.

 

Finding a balance that’s right for you

Of course, striking the right salary/dividend formula will be entirely dependent on your individual circumstances – there isn’t a one-size-fits-all solution. Many factors will need to be considered, such as:

  • Your age
  • Likely length of career
  • Projected income levels
  • Views of pensions planning and saving
  • Family status
  • Income from outside the business
  • IR35 risk status
  • Cash requirements to fund lifestyle

 

With all these factors to bear in mind, it can really help to turn to the professionals to help in your decision, like the team here at Intouch. We’ll help you get your business up and running and can advise on how best to withdraw income from your company. If you’d like to find out more, call our experts on 01202 375293. And, in the meantime, take a look at our new guide on combining salary with dividends.

 

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.

Demystifying dividends: a beginner’s guide

For many full-time contractors, the opportunity to earn a higher salary is among their main reasons for making the move. That, along with the freedom and enjoyment that comes with owning their own business.

If you’ve decided to set up your own Limited Company, you want to be certain it’s created in the most tax efficient way. After all, you’ll be working incredibly hard for your money, so you don’t want any more going to the tax man than has to.

Dividends are a great way to maximise the income you take from your business. If you’re not too sure of what they are, here’s an introduction:

 

In a nutshell…

Dividends are essentially a method of taking income from your business. They are payments made to the company’s owners – aka its shareholders – from accumulated profits, after business-related payments such as Corporation Tax and VAT have been made.

The main rule for withdrawing dividends is that your company must have enough ‘retained profit’ in the bank to cover them. Withdrawing dividends from untaxed earnings is illegal and, if caught, you could land yourself in serious hot water with HMRC.

Any profit that remains once you’ve withdrawn the dividends can stay in the account, where the money will hopefully accumulate over time.

 

What are the advantages?

The main benefit of drawing dividends from your Limited Company is that you won’t have to pay National Insurance Contributions (NICs), regardless of your Corporate Tax or Personal Income Tax rates. That’s why many business owners choose to pay themselves a modest salary, topped up with dividends.

 

Are there any disadvantages?

The only real drawback to dividends is that there must be profit in the business in order to declare them. If it’s not turning a profit, you’re still able to pay yourself a salary or bonus, even if it means you declare a loss – a situation you hopefully won’t find yourself in.

Taking dividends is something that must be decided on by every company shareholder, which could cause issues if there were multiple shareholders or an outside investor. Yet, these cases are unlikely to apply to you.

 

Who can dividends be paid to?

Dividends are separate to bonuses and salaries and can only be paid to the shareholders in the business. Many contractors will name a spouse as their shareholder, with dividends split depending on how much share capital each person owns. This can lead to even greater tax efficiency.

 

How are dividends taxed?

Dividends are taxed as personal income. The first £2,000 of dividend income is free of tax under the dividend allowance, with further dividends taxed at the following rates:

Within the basic rate threshold (income between £8,425 and £46,350 for 2018/19) = 7.5%

Within the higher rate (income from £46,351 to £150,000 for 2018/19) = 32.5%

At the additional rate (income exceeding £150,000 for 2018/19) = 38.1%

 

Find out more

Now you’ve got a clearer idea of what dividends are, there are rules to be aware of when it comes to declaring and balancing them with your salary. We thought it would be useful to put together a guide on combining salary with dividends for people making the move into contracting.

If you feel like you might need a helping hand setting up your business, the team at Intouch can help there, too. We’ll pair you up with your own expert Personal Accountant, who will help with everything from incorporating your company with HMRC, to setting up a business bank account, to insuring your company. Make the first step by calling our team today on 01202 375293.

 

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.

 

How much salary should I pay myself as a Limited Company contractor?

How much salary should I pay myself as a Limited Company contractor?

Making the right choice on the level of salary to draw as a Limited Company director and contractor is one of the more important decisions to take. Surprisingly though it’s not just an annual decision, taken at the beginning of each tax year, but one that should be revisited whenever changes occur in your circumstances.

To fully understand the mechanics affecting the choice of salary requires a working knowledge of Income Tax (PAYE), National Insurance and IR35, Corporation Tax and the rules concerning National Minimum Wage and that’s something your specialist contractor accountant can help you with. But to avoid a detailed technical analysis we can whittle these down to a short list of considerations:

I’m subject to IR35, so it makes no difference

If you are subject to IR35 your eventual salary is determined according to the defined rules of IR35; however you retain the choice of how much to take during the year that affect the amount of tax payable and when it is payable.

The Employment Allowance (EA) was introduced in April 2014 to provide a deduction of up to £2,000 from the Employer’s NI payable by your company. However EA is not available to any part of your salary determined as a deemed payment under IR35 and so only deductible against Employer’s NI payable on normal salary. You should therefore set a level of normal salary that utilises the EA limit. For 2015/16 the level of salary that fully utilises EA would be £22,552.

The second choice concerns timing of tax payments. Taking a monthly salary that utilises EA will result in quarterly PAYE and NI payments, whereas the tax on the deemed salary is payable at the end of the tax year. So it would appear better to keep your salary low enough to utilise the EA and leave the IR35 balance to be determined at the end of the year and pay PAYE and NI much later.

Although one point to appreciate is that any money taken from the company on account of a final IR35 salary will be a loan and subject to beneficial loan interest rules when the loan exceeds £10,000. A minor point not to be overlooked.

What about National Minimum Wage (NMW)?

New rules introduced in March 2015 mean that any failure to pay NMW can result in a fine of £20,000 per employee. Ok, this is unlikely to be an issue in practice, but HMRC can take action where the NMW rules apply and such a fine is an attractive motivator.

NMW only applies to Limited Company contractors who are the directors of the company where there is a contract of employment, and to the company’s employees. If you are one of the few contractors that has issued a contract to yourself then you should pay the NMW. Since October 2014 this is £6.50 and from October 2015 it is expected to be £6.70.

NMW has no influence over IR35 status and can be ignored where no contract of employment exists.

Are you thinking of pensions?

The level of salary taken affects the level of personal pension contributions you are able to make that take advantage of the tax benefits. If you pay pension contributions then you should seek advice from your financial advisor on the minimum required level of salary to support the tax benefits.

I’m outside IR35, pay enough to support my pension provisions and don’t have a contract of employment

Congratulations, you have complete freedom of choice. You can set any level of salary that now suits your personal circumstances and your view on tax. The next step in this discussion assumes that you want to minimise tax. If that’s not your driver then select any level of salary that you want and can be supported by the company’s income.

Most contractors are aware that dividends incur less tax than salary because NI does not apply to dividends. However there is a minimum level of salary that should be taken that overall reduces total tax (Income Tax, National Insurance and Corporation Tax). That minimum level used to be linked to the thresholds when NI became payable, however since the introduction of EA the best level of salary is linked to your personal tax allowance.

Personal Allowances (or your tax free allowance) changes every year. For 2015/2016 most contractors start off with Personal Allowances of £10,600. This typical level may be reduced if you have tax liabilities from earlier years that are collected via your tax code or you have any taxable benefits in kind. If you are not sure then obtain a copy of your tax code calculation from HMRC.

Your Personal Allowance is a tax free allowance and is set against your total income. So if you have other income such as interest or rental income then deduct the gross value of that other income and you are left with your available personal allowance.

The level of your available Personal Allowance is often the best level for your salary that achieves the least tax liability overall.

Let’s explain that with some examples:

Assumptions:

  • Personal Allowance is £10,600
  • No higher rate tax (but only to keep it simple)
  • No other income
  • Profit after expenses but before salary £40,000
  • Available dividends are declared
example salary

Conclusion: Salary at Personal Allowance is the least tax

Now let’s compare the result where Personal Allowances are £8,000 because of underpaid tax brought forward

Assumptions as above except:

  • Personal Allowance is restricted to £8,000

 example salary 2

Conclusion: Salary at Personal Allowance is still the least tax

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.