For personal and family companies it can often be beneficial to extract some profits in the form of a salary. If the individual does not have the 35 qualifying years necessary to qualify for the full single-tier state pension, then paying a salary which is equal to or above the lower earnings limit (LEL) for National Insurance purposes will ensure that the year is a qualifying year.
New tax rates and allowances came into effect from 6 April 2019, applying for the 2019/20 tax year. These have an impact on the optimal salary calculation for family and personal companies. We recently did an article for ListenToTaxman.com, which shows how a tax-efficient directors salary should look in 2019/20 – you can read it here.
What if employment allowance is unavailable?
As in previous years, the optimal salary level depends on whether or not the National Insurance employment allowance is available. Companies in which the sole employee is also a director are not able to benefit from the employment allowance. This means that most personal companies are not eligible for the allowance. Sad times.
Now, where the allowance is not available or has been utilised elsewhere, the optimal salary for 2019/20 is equal to the primary and secondary threshold set at £8,632 (equivalent to £719 per month and £166 per week).
At this level, assuming that the director’s personal allowance (set at £12,500) is available, there is no tax or employer’s or employee’s National Insurance to pay. Not bad, right?
However, as the salary is above the lower earnings limit of £6,136 (£512 per month, £118 per week), it will still provide a qualifying year for state pension and contributory benefit purposes. Again – not bad.
And an added bonus: the salary can be deducted from company profits before corporation tax is calculated, saving you paying 19% of the salary.
So to summarise, a salary of £8,632 x 19% gives you a £1640.08 corporation tax saving, while also ensuring you are entitled to a state pension.
What if employment allowance is available?
It is beneficial to pay a salary equal to the personal allowance (assuming that this is not used elsewhere) where the employment allowance (set at £3,000) is available to shelter the employer’s National Insurance that would otherwise arise if the salary exceeds £8,632.
Although employee’s National Insurance is payable when the salary exceeds the primary threshold of £8,632, this is more than offset by the corporation tax deduction on the higher salary. I’ll show you what I mean…
For 2019/20, a salary equal to the personal allowance of £12,500 exceeds the primary threshold by £3,868. Therefore, employee’s National Insurance of £464.16 (which is 12% of that £3,868 excess) is payable.
However, because the salary payments are deductible for corporation tax purposes, the additional salary of £3,868 saves corporation tax of £734.92 (£3,868 @ 19%). So even though you pay £464.16 in NIC’s, you save £734.92 in corporation tax. So all in all, you’re still making a saving on the difference of £270.46.
So, if the employment allowance is available, paying a salary equal to the personal allowance of £12,500 allows more profits to be retained (to the tune of £270.46) than paying a salary equal to the primary threshold of £8,632.
If the director has a higher personal allowance, for example, if they receive the marriage allowance, then of course the optimal salary would equal their adjusted personal allowance.
What if a Director is under 21?
Where the director is under the age of 21, the optimal salary would match the personal allowance of £12,500 (assuming that this is not used elsewhere) regardless of whether the employment allowance is available. No employer National Insurance is payable on the earnings of employees or directors under the age of 21 until their earnings exceed the upper secondary threshold for under 21’s set at £50,000 for 2019/20. Employee contributions are, however, payable as normal. Again – sad times.
So is there any benefit in paying a salary above the personal allowance?
Well, no. Once the personal allowance is reached it is simply not worthwhile paying a higher salary; any further salary payments will mean the employee begins paying income tax. At this point, the combined income tax and National Insurance hit ends up outweighing the corporation tax savings.
So if you want to stay truly tax efficient, stick to whichever one of the above methods applies to you.
Now, what if you want to pay yourself more than the personal allowance? Well, you can find out here, in our accounts manager Clare’s latest article for ListenToTaxman.com
Partner note: ITA 2007, s. 35, SSCBA 1992, s. 5; the Social Security (Contributions) Regulations 2001 (SI 2001/1004), reg. 10.
