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Salary and Dividend Mix – What Your Left With

Salary and Dividend Mix

Let’s look at different director/shareholder salary and dividend mix and see what you would be left with after tax.

The truth is, it will be less than last year due to the changes to the tax on dividends and Employment Allowance but what we want is to be left with as much as possible after the new rules come into force after 6 April, 2016.

Let’s assume you want to have a gross income up to the 40{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} higher rate band and you are a sole director/shareholder with no other employees (typical of many consultants and freelancers):

Option One (annual salary to NI threshold)

Gross salary £8,060 (no NI or tax to pay)

Dividends £7,940 (£5,000 plus balance of personal allowance tax free)

Dividends £27,000 (taxed at 7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214})

Total gross income £43,000

Less tax on £27,000 of dividends at 7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} = £2,025

What you are left with is £40,975

Company gets 20{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} tax relief on £8,060 salary = £1,612

Overall net remuneration and tax saved by the company is £42,587

Option Two (salary to tax threshold)

Gross salary £11,000 (no tax to pay)

Dividends £5,000 (tax free)

Dividends £27,000 (taxed at 7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214})

Total gross income £43,000

Less tax on £27,000 of dividends at 7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} = £2,025

less employees NI at 12{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} on £2,940 = £353

What you are left with £40,622

If you cannot claim the Employment Allowance then the company has to pay 13.8{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} Employers NI on £2,888 = £398.54

Company gets 20{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} tax relief on £11,000 salary plus the £399 Employers NI = £2,280

Overall net remuneration and tax saved (after deducting Employers NI) by the company is £42,503

Option One is marginally better and benefits from less administration paying National Insurance Contributions to HMRC.

If, however, you have other employees and qualify for the Employment allowance, then Option Two is marginally better as the company will not have to pay Employers NI contributions.

Option One is likely to be more beneficial for many consultants and freelancers who only employ themselves as directors.

Again, another affect would be if you have other employees that use up the Employment Allowance and then option one is better again.

Remember: Please get advice from your accountant or payroll bureau before taking action on the above

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Sole Directors Optimum Salary and Dividend 2016/17

Salary and Dividend

Many consultants, freelancers and other small limited companies operate as a one person/director company with no other employees.

For these business owners we look at the optimum salary and dividend mix each year. unfortunately, with changes to the Employers Allowance together with changes to the taxation of dividends from 6 April, 2016 more tax will have to be paid.

 

Optimum Salary and Dividend

If you have no employees other than yourself as the sole director (and therefore cannot claim the £3,000 Employment Allowance) then it may be better to take a salary up to the National Insurance Primary threshold (PT) and the balance in dividend.

You have to earn above the National Insurance Lower Earnings Limit (2016/17 £112 per week £486 per month) to keep your entitlement to future state benefits and pension. There is no National Insurance to pay at this level until you exceed the National Insurance Primary Threshold (2016/17 £155 per week or £671.66).

Due to the changes coming in from the 6 April, 2016, if you are the sole director/employee of your business, I suggest a monthly gross salary of £670 which is just below the threshold for paying Employee and Employer National Insurance contributions and take the balance in dividend.

From 6 April, you will have to pay some tax on the dividend but this can still show a small saving on going through the payroll. See Dividends Tax Shocker.

There are different optimum salary and dividend mixes for other circumstances such as if you have other employees or directors. contact your accountant or payroll bureau for advice.

Remember to get advice from your accountant or payroll bureau before taking action based on the above

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Dividends Tax Shocker

Tax on Dividends Concept

How do the changes to the taxation of dividends from April, 2016 affect owner-managed and family companies?

At present, owners of owner-managed and family limited companies would would pay themselves a minimum salary to cover the personal allowance and avoid payment of tax and National Insurance on it but enough to qualify for state pension purposes.

The balance of their remuneration would be in the form of dividends (provided there is enough retained profit in the company).

The Present Situation

At the moment, dividends have a 10{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} tax credit so that for every £100 dividend actually paid by the company (the net dividend) is divided by 9 and then multiplied by 10 to get to the gross dividend of £111.11.

How much additional tax would you be liable to pay at present?

  • Provided you are a basic rate tax payer (20{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} band), you have no further tax to pay;
  • If you are a higher rate tax payer (40{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} band), you will have a further 25{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} of the £100 net dividend to pay in tax;
  • If you are an additional rate tax payer (45{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} band), you will have a further 30.6{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} of the £100 net dividend to pay in tax

The reason that basic 20{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} rate tax payers have no further tax to pay is that the company has already been taxed 20{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} on the profit before it is paid out as dividend.

What is the Benefit of Business Owners Paying Themselves with Dividends?

Although the company does not get tax relief on dividends paid (unlike wages and salaries), dividends are attractive as you do not have to pay National Insurance contributions on them and no additional tax is payable until your income goes into the higher 40{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} after income reaches the limit of the basic rate band of £31,785 plus your personal allowance (2015/16).

What will Change from April 2016?

The 10{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} dividend tax credit will be abolished on 6 April, 2016. In its place, all taxpayers will receive a tax free dividend allowance of £5,000 which is offset against the first £5,000 of taxable income. This means that someone who only has dividend income will be able to receive £16,000 in dividends with no further tax to pay (£11,000 personal allowance in 2016/17 plus the £5,000 dividend allowance).

Where dividends are received above the dividend allowance, from 6 April, 2016 the balance will be taxed at 7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} for basic rate tax payers, 32.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} for higher rate tax payers and at 38.1{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} for additional rate tax payers.

In effect, from 6 April, 2016, all tax payers receiving dividends above the £5,000 dividend allowance, will be paying 7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214} more tax than prior to 6 April, 2016.

This additional tax is tackling owners of owner-managed companies who pay themselves a small salary and take the balance in dividend to avoid National Insurance.

However, like a blunderbuss, it hits the pensioners who do not pay National Insurance anyway and the higher earning employees who pay the maximum National Insurance (at normal rate) that have dividend income from investments.

Dividends in ISA’s and pension funds will not pay the tax.

HMRC Examples

The way the allowance will work in different situations is demonstrated in the examples below.

Where appropriate to the calculations, the examples use the limits that will apply from April 2016:

  • Personal Allowance: £11,000
  • Basic Rate Limit: £32,000
  • Higher Rate Threshold: £43,000

Example 1

“I receive less than £5,000 per year in dividends”

From April 2016 you won’t have to pay tax on your dividend income as it is within your new Dividend Allowance.

Example 2

“I receive dividends of £600 from shares invested in an ISA

As is the case now, no tax is due on dividend income within an ISA, whatever rate of tax you pay.

Example 3

“I have a non-dividend income of £6,500, and a dividend income of £12,000 from shares outside of an ISA

With a Personal Allowance of £11,000, £4,500 of the dividends are under the threshold for tax. A further £5,000 comes within the Dividend Allowance, leaving tax to pay at Basic Rate (7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214}) on £2,500.

Example 4

“I have a non-dividend income of £20,000, and receive dividends of £6,000 outside of an ISA

You won’t need to pay tax on the first £5,000 of dividends due to the Dividend Allowance, but will pay tax on £1,000 of dividends at 7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214}.

Example 5

“I have a non-dividend income of £18,000, and receive dividends of £22,000 outside of an ISA

Of the £18,000 non-dividend income:

  • £11,000 is covered by the Personal Allowance
  • the remaining £7,000 to be taxed at Basic Rate

Of the £22,000 dividend income:

  • the Dividend Allowance covers the first £5,000
  • the remaining £17,000 of dividends to be taxed at the Basic Rate (7.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214})

Example 6

“I have a non-dividend income of £40,000, and receive dividends of £9,000 outside of an ISA

Of the £40,000 non-dividend income, £11,000 is covered by the Personal Allowance, leaving £29,000 to be taxed at basic rate.

This leaves £3,000 of income that can be earned within the basic rate limit before the higher rate threshold is crossed. The Dividend Allowance covers this £3,000 first, leaving £2,000 of Allowance to use in the higher rate band. All of this £5,000 dividend income is therefore covered by the Allowance and is not subject to tax.

The remaining £4,000 of dividends are all taxed at higher rate (32.5{8ee99a90b51e2217d12101096daf2ee9e40c43b9c2fa413e32f91dd0a196a214}).

 

 

 

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