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Most tax efficient director’s salary and dividends for 2021/22

We've discussed the changes in Budget 2021 recently and in this post we'll discuss the most tax efficient combination of director's salary and dividends for 2021/22. If you want to know the best combination for the current tax year you can find this out here.

director's salary and dividends for 2021/22

The new rates and allowances for 2021/22 

For the 2021/22 tax year the position for English taxpayers is as follows:

  • The tax free personal allowance increases to £12,570
  • The basic rate threshold increases to £50,270
  • The tax-free dividend allowance remains at £2,000  

Whilst the 2021/22 tax rates for taxpayers in England Northern Ireland and Wales are as shown above, the situation is slightly different for Scottish taxpayers as you can see here

What is the most tax efficient director's salary and dividends for 2021/22?

It's important to mention that in our article we assume the following:

  • Your contract is not caught by IR35 - see here
  • You are claiming the standard personal allowance
  • You are UK tax resident
  • There are no other issues such as student loans or child benefit high income tax charge
  • You are only paying yourself salary and dividends from your company

If you're a director of your own company, usually the most tax effective method of profit extraction is to take a low salary and the balance as dividends. This has the following advantages:

  • Taking a salary at the minimum level triggers a national insurance record for your state pension and the personal allowance level
  • Your company can claim the the cost of your salary as a corporation tax deduction, saving corporation tax at 19%
  • Your company doesn't need to pay you all of it's post tax profits each accounting period. Therefore dividends can be managed to minimise your personal income tax liability
  • National Insurance currently isn't payable on any dividends paid to you by your company

Before determining the most tax efficient director's salary and dividends for 2021/22 you need to consider the current national insurance thresholds. These are as follows:

  • Lower Earnings Limit - If you keep your salary above this limit, you'll preserve your future entitlement to start pension and benefits. However you don't actually need to pay any contributions. For the 2021/22 tax year it is £520 per month or £6,240 per annum  
  • Primary Threshold - Once you earnings start exceeding this threshold you are liable to employee's national insurance. The limits are £797 per month or £9,568 per annum for the 2021/22 tax year  
  • Secondary Threshold - When your earn above this threshold, your company is required to pay employer's national insurance. The threshold for 2021/22 is £736 per month or £8,840 per annum 

So as you may have noticed the employee's national insurance threshold is higher than the company's! 

Tax efficient director's salary and dividends for 2021/22 - First Option

The first strategy is to pay yourself a salary up to the Employer's National Insurance Threshold - for 2021/22 this will increase to £736 a month or £8,840 per annum. Note this is actually less than the Employee's National Insurance Threshold which is £797 per month or £9,568 per annum.

You can then pay dividends of £41,430 without paying any higher rate tax (basic rate band of £50,270 less salary of £8,840).

At this level of dividends you will have basic rate tax to pay of £2,677.50 calculated as follows:

  • No tax up to the personal allowance of £12,570 (used £8,840 for salary and £3,730 for dividends
  • There will be no tax on dividends of £2,000 as this will be covered by the dividend allowance 
  • £35,700 (£41,430 less £3,730 less £2,000) dividends taxable at 7.5% - £2,677.50

The net cash you'll receive is £47,592.50 (£50,270 less £2,677.50) in your pocket after tax.

The company will save corporation tax of £1,679.60 (£8,840 * 19%) with this strategy.

Tax efficient director's salary and dividends for 2021/22 - Second Option

If you are able to claim the employment allowance (which is currently to £4,000then you may want to pay yourself a salary up to the level of the personal allowance (£12,570). For example this might be the case if you or your spouse work full-time in the business.

However this strategy will only be effective if you haven't already utilised the employment allowance against the NI due on your other employee's salaries.

On the basis you have surplus employment allowance, we recommend you pay yourself a salary up to the personal allowance of £12,570. You can then pay draw dividends of up to £37,700 without paying higher rate tax. (see above).

Using this approach, there will be £3,023 basic rate tax and Employee's national insurance to pay.  You can see how this is calculated below:

  • Employer's National Insurance - £514.74 (being £12,570 less Secondary Threshold £8,840 = £3,730 *13.8%) . However in this example we're assuming that this is covered by the employment allowance.
  • Personal allowance - £12,570 fully utilised against salary
  • No tax for the first £2,000 dividends due to the dividend allowance
  • £35,700 (£37,700 less £2,000) dividends taxed at 7.5% - £2,677.50
  • Employee's national insurance payable on salary - £360.24 (£12,570 less £9,568 = £3,002 * 12% (assuming NI letter = A)

Using this strategy you'll have net cash of £47,232.26 (£50,270 less £2,677.50 and £360.24) in your pocket after tax.

Your company will also have a corporation tax saving of £2,388.30 (£12,570 * 19%) with this strategy.

Tax efficient director's salary and dividends for 2021/22 - Best Option

Whilst option one results in more money in your pocket personally, there is a greater corporation tax saving in the second strategy.

So if you take into account the corporation tax saving when taking a higher salary, you would be better off by £348.46 if you choose the second option.

For more useful information, check out our Ebooks here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].

Alternatively, please feel free to complete our Business Questionnaire here.

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