Most tax efficient salary and dividend structure for 2019/20

As a limited company owner or Director, one of the key items on your tax planning should be ensuring that you are paying yourself the optimum level of salary and dividends in 2019/20. Here’s how your salary and dividends will be taxed this year plus 2 tax efficient strategies you should consider.

Salary and Dividends in 2019/2020 – New Tax Rates

For 2019/2020 the Personal Allowance has increased from £11,850 to £12,500. Essentially, this means that your first £12,500 of income is tax free.

On earnings after this the income rates are as follows:*

  • From £12,500 to £50,000 = 20%
  • From £50,000 to £150,000 = 40%
  • £150,001 and above – 45%

For 2019/2020 the Dividend Allowance remains the same as in 2018/19 at £2,000. This means that your first £2,000 of dividends are tax free!

On dividends over £2,000, the income is taxed as follows:

  • You won’t pay any tax if you have un-used personal allowance which covers your additional dividend (£12,500 for 19/20).
  • Dividends in the basic tax rate band (Up to £50,000 in 2019/20) will be taxed at 7.5%.
  • Dividends above the basic tax rate band but below the additional rate tax band (from £50,000 – £150,000 in 2019/20) will be taxed at 32.5%.
  • Dividends in the additional rate tax band (£150,001 and above for 2019/20) will be taxed at 38.1%.

The Optimum Directors’ Salary and Dividends Structure for 2019/20

A lot of small business owners take a low salary from their business combined with a higher dividend as this is a tax efficient strategy. The rationale behind this is as follows:

  • Withdraw a low gross salary that is no higher than the Personal Allowance (£12,500 for 2019/20). No tax will be paid on this.
  • The business will save Corporation Tax on the salary taken (19% for 2019/20).
  • The gross salary should also be high enough for National Insurance purposes in order to protect future pension and benefit entitlement. You’ll usually need to have 10 qualifying years on your national insurance record to get any new State Pension. You may not pay national insurance contributions if you earn less than £166 a week in 2019/2020. Find our more by clicking here.
  • Additional amounts can be withdrawn as dividends which do not attract National Insurance.
  • However, it is important to note that dividends are not a tax allowable expense and therefore do not save the company Corporation Tax.

Utilise the Employment Allowance BUT With Caution

You may also wish to utilise the Employment Allowance which was introduced in 2015. This enables employers not the pay the first £3,000 of employers’ National Insurance in 2019/20.

The Employment Allowance generally means that it is slightly more tax efficient to take a gross salary up to the Personal Allowance threshold. However, the Employment Allowance is no longer available to companies where the only person on the payroll is a Director.

This has however left open a slightly ‘grey area’, for example;  where there is a husband and wife who are both Directors of the company and there are no other employees. In a scenario like this, we would recommend only claiming the Employment Allowance if both parties have an active and regular role in the business.

With this in mind, we have outlined two different salary and dividend options which are put together on the basis that you wish to extract salary and dividends up to the higher rate tax band (£50,000) but no higher.

We have made some key assumptions when preparing these calculations:

  • You are a UK resident
  • You have no student loan balance
  • Your only income is your salary and dividends from your company
  • You have a standard personal allowance
  • Your company has sufficient post tax profits to support these dividends

#EFFICIENT STRATEGY  1 – Claiming the Employment Allowance 

Take an annual salary of £12,500 (gross) – the standard tax free Personal Allowance for 2019/20. No income tax will be payable on this amount, however, employee’s National Insurance will be approximately £464.

You will not need to pay employee’s National Insurance as this will be covered by the Employment Allowance. (Providing that you are allowed to claim it!)

If you have other employers and their salaries already use up the £3,000 Employment Allowance, then you would be better opting for strategy 2 below.

In terms of dividends, the basic rate tax band ends at £50,000. This means that you have £37,500 of dividends to take (£50,000 – £12,500 = £37,500). The first £2,000 of this is tax free and the remainder will be taxed at 7.5%.

#EFFICIENT STRATEGY 2 – Take a Salary up the National Insurance Primary Threshold

If you are not entitled to claim the Employment Allowance, or if you want to keep your administration simple, then this is a good strategy for you.

First of all, you should familiarise yourself with these 2 National Insurance thresholds:

  1. Lower Earnings Limit – As mentioned above, your earnings need to be above this to protect your entitlement to future state pension and benefits.
  2. Primary Threshold – if your earnings are above this then you have to start paying national insurance. So, the goal is for your earnings to reach the Primary Threshold but no higher.

Again, as we mentioned above the National Insurance Primary Threshold for 19/20 is £166 a week which is equivalent to an annual salary of £8,632. Taking a monthly salary of £715 would enable you to stay below this threshold and is a nice round amount. This would equate to £8580 per annum.

Next, you can take £5,920 of dividends tax free. Here’s why…

With regards to dividends, we can apply the same principles as in strategy 1. However, taking a lower salary of £8,580 would leave £3,920 of your Personal Allowance for 2019/20. (£12,500 – £8,580 = £3,920). This, and the next £2,000 of dividends, can be taken tax free as they are also within the Dividend Allowance.

Finally, this leaves a balance of dividends of £35,500 taxed at 7.5%  = £2,663 of tax.

Please see a full breakdown of both strategies below including figures for the 2019-20 tax year:

Strategy 1Strategy 2
Gross salary£12,500£8,580
Dividends£37,500£41,420
Total gross income£50,000£50,000
Employee national insurance£464£0
Tax on dividends£2,663£2,663
Net cash in pocket£46,873£47,338
Corporation tax saved on salary£2,375£1,630
Overall saving of Strategy  1£281

If you’re the owner or a Director of a small Limited Company and would like to speak with one of our Independent Financial Advisers who specialise in Business Financial Planning please call 01244 347 583 or email info@innesreid.co.uk to arrange a consultation at our expense. We can also recommend numerous local Accountants whom we have worked with for many years.

*DISCLAIMER: Please note that there are further thresholds and tax issues to be aware of but we have kept the information simple for the purposes of this article. The content should not be taken as advice and you should discuss your specific circumstances with an Independent Financial Adviser and/or your Accountant before taking action. Also be aware that this article has been written based on available information at the date of publication, May 2019. There may be changes to the 2019/2020 tax year still to come.

 

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