For 2021, what's the best dividend-salary mix for limited company directors?
For limited company contractors, drawing down income from your company in the most tax-efficient way possible is an important thing to get right. However, asks Daniel Mepham, managing director of SG Accounting, how do you actually go about doing this for 2021?
The optimum dividend-salary mix is always important for tax-efficiency if you’re a PSC contractor, but knowing what the numbers should look like for the next 12 months, and why, is best to sort now before this significant year for the contractor industry really gets underway. To that end, let’s also explore dividend-salary considerations in light of Budget 2021 on March 3rd and private sector IR35 reform on April 6th.
Paying yourself a salary and dividends
As a director of your own limited company, you’ll have flexibility over when and how you pay yourself, along with any other co-directors.
For the basis of this piece, exclusively for ContractorUK, we’ll use the example of being outside IR35, and therefore will display the most tax-efficient way to draw down a small, tax-efficient salary, along with dividends, to extract company profits.
One of the main benefits of doing so is that whereas any salary you pay yourself will be subject to National Insurance Contributions (NIC), dividends are not. So by paying yourself a small wage and topping up your earnings with dividends, you’ll be making the most from your contractor pay.
What should you pay yourself in 2021?
It’s advised also to take a small salary as the cost is deductible against the company’s Corporation Tax. That being said, the tax benefits from taking a salary reduce as you work your way through the prevailing NIC thresholds and income tax. Next, let’s look at some general factors to take on board when working out your optimum salary total:
1. £8,788 salary (no income tax or NIC)
- Should you be entitled to the full personal allowance (your contractor accountant will be able to advise you on this), then by taking a salary of £8,788, you won’t have to pay any income tax, so long as your salary does not exceed the standard personal allowance of £12,500 (for 2020/2021 tax year).
- For the 2020/21 tax year, your company will only start having to pay Employer NICs once your salary reaches £8,788. You’ll also need to start paying Employee NICs once your salary reaches £9,500.
- Therefore if your company isn’t claiming the Employment Allowance, paying yourself a salary of £8,788 is a tax-efficient way for the tax year 2020/21, without having to pay NICs.
- Remember that any income from any other sources is also counted in this (i.e. savings and rental income, plus potentially any salary from previous work).
- You don’t have to pay yourself the National Minimum Wage, unless you have a contract with your own company that states otherwise.
- It’s worth noting that this salary is above the Lower Earnings Limit for National Insurance required in order to be eligible for state benefits, which for the tax year 2020/21 is £120 per week / £6,240 per year).
2. £9,500 salary (Some National Insurance admin required, but more tax-efficient than salary 1; above)
- At this salary there is no Employee NICs or income tax, but you will have to pay Employer NICs at 13.8% for the additional salary (so £9,500 - £8,788 = £712). £712 x 0.138 = £98.26.
- You won’t be required to pay the 19% Corporation Tax or the extra Employer NIC costs on the additional salary, so effectively you’ll be saving £153.95 (0.19 x £712 + £98.26).
- Overall this will give your company a small saving of £55.69 per year, compared with £8,788.
- Depending on your circumstances there may be some admin costs associated with Employer NICs at this salary level. Some contractors may prefer to have no NI concerns by drawing down the smaller salary of £8,788, while others won’t incur any additional costs, as their NI is dealt with by their accountant at no extra cost. This comes with strict payment obligations, so the salary of £8,788 is advised.
3. £12,500 salary (if you’re able to claim the Employment Allowance then this is the most tax-efficient salary for you)
If you’re outside IR35, not the sole director/employee of your company and you’re not earning over the Secondary Threshold, it could be tax-efficient to pay yourself a higher salary than the £8,788, and then claim the Employment Allowance (EA).
- If your company is eligible for the Employment Allowance (your accountant will be able to check this for you) then they will refund you any Employer NICs your company has paid, up to the value of £4,000.
- You will still need to pay Employee NICs on any salary that exceeds the £9,500 salary.
- So should your company pay you £12,500 during this tax year, you won’t pay any income tax and your salary is deductible against your company’s Corporation Tax bill, so you’ll only pay £360 in Employee NICs.
- The Employer NICs of £512.26 will be refunded to your company via the EA scheme. But beware, you are unable to claim the EA if you are the sole director and have no other employees at your company.
- Your company will also make a saving of £705.28 in Corporation Tax if you take a salary of £12,500 rather than £8,788.
- Therefore if your company is eligible for the EA, then you’re better off taking a £12,500 salary.
How much should you take in dividends?
Once you’ve made a decision on your salary (and any employees your company may have), it’s time to think about dividends. Any remaining profit in the company can be shared among the shareholders in the form of dividends, which for the tax year 2020/21 are taxed at the:
- Basic rate – 7.5%
- Higher rate – 32.5%
- Additional rate – 38.1%
There’s also the dividend allowance (£2,000), which sits inside your existing tax bands. So these tax rates are applicable once the total monthly ‘wage’ of your salary plus your dividend amount is added together. You then pay the tax that’s left once your total amount minus your salary and remainder of any personal allowance has been accounted for, based on which tax rate you sit within.
From paying yourself a smaller salary as previously outlined, depending on your circumstances topping up your salary with dividends will be the best way to take home more pay. Your accountant will be able to advise further and give you exact figures based on your own personal data.
Are these dividend rates expected to change at Budget 2020?
The tax allowances and rates are always subject to change each year and the Chancellor will confirm the rates in the Budget. We will follow up with any amended or new guidance for ContractorUK readers based on what (if anything) is announced on March 3rd , with a view to spelling out the most tax-efficient route.
What about dividends under IR35 reform from April?
The rules used to determine IR35 status are not changing from April 2021, so in theory, if you are legitimately contracting through a limited company now, then you should be able to continue to do so post-April and as such, take a lower level of salary and higher dividends.
However, our experience of the off-payroll rules that were implemented in the public sector suggests that some end-hirers may take a more risk-averse stance, deeming a larger proportion of contractors as 'inside IR35' as a result.
Assuming this happens in the private sector, it may result in some contractors needing to work through an umbrella company from April 2021.
Such a working arrangement creates an overarching contract between you and the hirer and deals with your admin, tax and payroll. The hirer pays your umbrella company which takes off their fee, National Insurance and income tax and passes what’s left on to you -- your salary . So there's no longer any dividends to consider as you’re effectively taxed as an employee.
For these reasons, many contractors may find themselves wanting to switch between their limited company and an umbrella company at short notice, including while they challenge a client’s IR35 status determination, look for a new contract, or negotiate their fee to cover any take-home pay shortfall.
Are there any other considerations for contractors?
It’s very important for contractors to keep up-to-date with all legislation as part of the ‘dos and don’ts’ of running your own limited company. By choosing a specialist contractor accountant you can largely sit back, relax and have peace of mind, partly as the complicated ‘jargon’ on directing a limited company should be translated for you into simple and easy to understand terms.
Paying yourself a salary and taking dividends is all about accuracy and timing, without these it can be easy for it all to fall apart. Ensure you enlist the services of an expert contractor accountant, who will be able to advise on how to pay yourself in 2021 and work with you going forward.