The tax rates and allowances for the new tax year have already been published, and the National Insurance contributions have been shrouded in controversy. Which leaves us questioning, what is the best combination of salary and dividends for the upcoming tax year?
The Spring 2022 Budget confirmed the employee NIC threshold for 2022/23 has increased by £3,000 to £12,570, aligning the NIC threshold with the Income Tax personal allowance. But with the increase not taking effect until the 6th of July 22, the general perspective is that the annualised lower earnings limit for NIC is £11,908 and not the increased rate.
The Tax Rates and Allowances for 2022/23
The position for the English taxpayers for the next financial year starting April 6th, 22, looks like this:
- The tax-free personal allowance remains at £12,570
- The basic rate threshold remains at £50,270
- The tax-free dividend allowance remains at £2,000
Scottish taxpayers have different rates from those in England, Wales and NI.
The New Dividend Tax Rates
Dividend tax rates are the same for all UK taxpayers; noteworthy that these rates increase by 1.25% from the previous tax year. The increase impacts a company director/shareholder’s choice in regards to the best combination of salary and dividends for the 22/23 year.
The Best Salary & Dividends Combination for 22/23
It’s standard practice for company directors and shareholders to extract any post corporation tax profits by paying themselves a low salary with the balance as dividends. This approach has several advantages:
- Paying a nominal salary could potentially trigger a national insurance record for a state pension.
- Any payment of a director’s salary can be claimed as a tax deduction by the company.
- There is no National Insurance to pay for Dividends.
- There is no requirement for the company to distribute all its post-tax profits to the director as dividends. The company can retain dividends and claim Business Asset Disposal Relief when it gets closed down.
To determine the best combination, you’ll have to consider the current national insurance thresholds.
These are the current thresholds:
- Lower Earnings Limit. If you pay your salary above this limit, you’ll keep your future entitlements to state pension and benefits. In addition, you don’t need to pay any contributions to do so, as the limit for 22/23 is £533 per month or £6,393 per year.
- Primary threshold. Once your earnings pass this threshold, you’re liable to pay employee’s national insurance. The new limit increases from £823.33 to £1,047.50 a month as of the 6th of July, or £11,908 a year.
- Secondary Threshold. Earning above this threshold means the company begins paying employer’s national insurance. For 22/23, the limit is £758 per month, or £9,100 a year. Unlike the primary, this threshold is not increasing.
Option A – The Best Dividend/Salary Combination
If you qualify for the employment allowance, which is now £5,000 a year, you could pay a salary of up to £12,570 (personal allowance). This scenario might be because you and your spouse work full-time within the company or you have other employees. However, this option is ineffective if you have already used the employment allowance against employees’ salaries.
On the other hand, if you have any remaining employment allowance, we recommend you pay yourself a salary up to the personal allowance and then draw dividends up to £37,700 without paying the higher tax rate.
Taking this option results in £3,480.17 basic rate tax and employee’s national insurance to pay. Calculated like this:
- Employer’s National Insurance – £522.23 (being £12,570 less Secondary Threshold £9,100 = £3,470 *15.05%). However, we assume that the employment allowance covers this in this example.
- 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 8.75% – £3,123.75.
- Employee’s national insurance payable on salary – £87.71 (£12,570 less £11,908 = £662 * 13.25% (assuming NI letter = A).
Choosing this option means you’ll have net cash of £47,058,54 (£50,270 less £3,123.75 and £87.71) in your pocket after tax.
With this strategy, your company will also have a corporation tax saving of £2,388.30 (£12,570 * 19%).
Option B – The Best Dividend/Salary Combination
The second option is to pay yourself a salary up to the Employer’s National Insurance Threshold, equating to £9,100 a year and is lower than the Employee’s National Insurance Threshold at £11,908 a year.
You can then pay dividends of £41,174 without paying the higher rate tax and only have to pay the basic rate tax of £3,123.75, calculated as follows:
- No tax up to the personal allowance of £12,570 (£9,096 of which is salary and the balance of £3,474 for dividends
- There will be no tax payable on dividends of £2,000 as the dividend allowance covers this.
- £35,700 (£41,174 less £3,474 less £2,000) dividends taxable at 8.75% – £3,123.75
The net cash you’ll receive is £47,146.25 (£50,270 less £3,123.75) in your pocket after tax. With this strategy, your company will save £1,728.24 (£9,096 * 19%) on corporation tax.
So What is the Best Combination?
Option B guarantees more personal money in your pocket, despite the increased Primary Threshold. On the other hand, Option A provides your company with greater corporation tax savings.
Therefore, by considering the savings of Option A with a higher salary, you could be £572.35 better off with this option.
If you are unsure which approach is the best for you and your company, contact the tax experts at TS Partners and discover how we can help you choose the right combination for you and your business.
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