Contractors, set your optimum dividend-salary mix for 2019/20
With the upcoming IR35 changes to the private sector currently due to kick in from April 2020, it's more important than ever to ensure that limited company contractors are optimising their salary and dividend extractions for the 2019/20 tax year, writes John Falcon of JF Financial, a boutique online accountancy firm for contractors.
This article is aimed at UK resident limited company contractors with straightforward tax affairs, such as no other income outside of their contracting work. In reality of course, one individuals’ circumstances can be very different to another’s, so professional tax advice should be sought for your own circumstances. Here, I want to provide general advice only.
To do that, let’s first go back to basics and remind ourselves of the differences between a shareholder and a director. The shareholders of a limited company own the company through their holding of shares and they appoint directors to run the company on their behalf day to day. In practice, for limited company contractors, the director(s) and shareholder(s) are usually the same person, but it’s important to understand the difference.
The directors of a company can be paid a salary as remuneration for performing their duties for the company, and the shareholders can be paid dividends out of post-tax profits, assuming there are sufficient cumulative retained profits to support the dividends.
Assuming you are operating outside IR35, the standard advice is to pay yourself a low salary, with the balance of extractions being taken as dividends.
When it comes to setting the best level of salary for 2019/20, there are two important national insurance thresholds to be aware of:
- The ‘lower earnings limit’ (£6,136 for the year). As long as you pay yourself to at least this level, it means you protect your national insurance stamp for the year, which is important for your entitlement to the state pension later in life.
- The ‘primary threshold’ (£8,632 for the year). If you pay yourself above this level you actually start paying Employee’s National Insurance
Typically, for most limited company contractors, paying a salary no higher than the primary threshold, £8,632, is the suggested plan - this would be £719 per month.
As this is within the personal tax free allowance (£12,500 for 2019/20), there is no personal tax to pay on this salary (assuming no other sources of income).
For tax year 2019/20, dividends are taxed at the rates outlined below.
- If any tax free personal allowance is left ‘un-used’ after taking into account the salary (and any other income), then that can be allocated against your dividends
- You then have the tax-free dividend allowance, which remains at £2,000 for 2019/20
- Above that, any dividends in the basic rate tax band (total income up to £50,000) are taxed at 7.5%
- Any dividends in the higher rate tax band (income above £50,000) are taxed at 32.5%
- Dividends in the additional rate tax band (income above £150,000) are taxed at 38.1%
Optimum salary and dividends
The optimum position for tax-efficiency, assuming there are sufficient post-tax profits in the company, is to not go into the higher tax band and restrict your personal income to £50,000, as illustrated in the table below (figures have been rounded):
|Cash in pocket||£3,945||£47,338|
Got another director?
If there is another director / employee on the payroll, then you could consider claiming the National Insurance Employment Allowance and taking a slightly higher salary, up to the personal allowance of £12,500, but taking less dividends to still limit your total income to £50,000. This would potentially save a little more tax, but at the expense of not being able to extract quite so much out of the company.
Overall, the savings using this method are not that large and it introduces some additional admin due to having to pay national insurance to HMRC, so we tend to recommend the simpler method highlighted above, which has the bonus of enabling you to extract more cash out of your company.
Other tax planning considerations
The tax-efficient salary and dividend levels highlighted above are all well and good, but what if you have additional profits building up in your company? Or perhaps you are thinking ahead to the IR35 changes which are currently coming to the private sector in April 2020.
Here are some further and final considerations:
- Employer pension contributions
You may want to consider your limited company paying some employer pension contributions direct into your personal pension scheme – this has the added benefit of corporation tax savings on this expense. Be aware of the annual and lifetime pension allowances.
- Spouse salary / dividends
If you have a spouse you may want to consider them becoming a director (or company secretary), to enable you to pay them a low salary and/or you may want to make them a shareholder, to enable them to receive some dividends from your company. You will have to consider what other sources of income they already have before assessing if this is a possibility. This will require some changes to the share structure of your company.
- ‘War chest’
Building up some profits in your company is not necessarily a bad thing and it can be very useful if you want to take an extended break in the future or if you end up having a large gap between contracts.
There is potentially a way to extract cash from a limited company as capital, rather than as dividend income, if a company is closed down in the correct way – this can have significantly lower tax rates but it’s a complicated area and one in which you need to get professional advice on before taking action.
- Additional dividends
You could simply extract additional dividends and accept the higher rate of taxation.
Please note, the information provided in this article is of a general nature. It is not a substitute for specific advice in your own circumstances. While the contributor has endeavoured to use reasonable efforts to furnish accurate, complete, reliable, error free and up-to-date information, it does not warrant that it is such. Both it and its associates, including the publisher, disclaim all warranties.