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Setting the optimum salary for Directors in the year ahead.

During the Spring Statement, the Chancellor announced changes to the National Insurance thresholds for employees, which are set to impact the calculation of the optimum Director’s salary.

From July 2022, the Primary Threshold (PT) for National Insurance will be increased by £3,000 to £12,570 (bringing parity with the tax-free personal allowance threshold).

However, before this date, the threshold for employees to pay National Insurance Contributions (NICs) will remain at £9,880 per year.

Another consideration is the Secondary Threshold for employer NICs, which will only rise to £9,100 in April for 2022-23.

Additionally – regardless of how far away it may seem – it is important to plan for your retirement. For the approaching tax year, an annual salary must be at least £6,396 (the lower earnings limit) to meet the qualifying contribution requirements for the state pension.

What is the impact on Directors’ salaries?

When taking these factors into account, to maximise savings, whilst still qualifying for a state pension, the salary must not exceed £11,908 per year during the next 12 months, which is equivalent to £992 per month.

This is because the change in the PT will only commence from 6 July 2022 and earlier months remain at the original amount of £9,880 per annum.

As a result, the employee’s NI threshold is only £11,908 for the tax year 2022/23 as it is apportioned between the two different rates.

Whilst this may sound like a smaller sum than expected, most Directors are likely to make up additional income through the use of dividends.

From the business’ perspective, paying the Director a salary yields the benefit of being a tax-deductible expense, that paying in dividends does not.

However, in paying dividends Directors may be taxed if they receive more than £2,000 per year in dividend income.

The rates at which they are taxed increase from April by 1.25 percentage points, so Directors must find the right balance for them and their business.

Why pay a salary at all given the benefits on offer?

It might seem as though paying no salary at all is the best option, but a salary is considered a tax-deductible expense and so a company can deduct tax at 19% (the current Corporation Tax rate).

In comparison, a dividend payment is not tax-deductible and, therefore, a company stands to make a Corporation Tax saving of £2,262 by paying a salary at the optimal rate of £11,908 to the Director in the 2022/23 tax year.

From a Director’s perspective, the payment of a salary above the Lower Earnings Limit ensures that they make sufficient contributions to achieve a qualifying year for the State Pension.

Paying a salary of £11,908 still leads to Employers’ NICs, so why not charge less?

Previously many accountants have recommended that companies should pay Directors’ salaries up to the Secondary Threshold (the level at which employers must begin making contributions), which is £9,100 (2022/23).

Paying a salary at this level avoids PAYE, employees NI and employers NI. However, an optimum salary of £11,908 saves more in Corporation Tax than is lost through the employer’s NICs.

For example:

The extra employers’ NI totals £422 (£2,808 at 15.05 per cent) but the corporation tax saved totals £613 (£2,808 at 19% + £422 at 19 per cent).

The difficulty with incurring employers’ NICs of £422 is that the payments will need to be made monthly (£35 per month) or quarterly (£105 per quarter) to HMRC.

For some businesses, this additional admin may not beat the total saving or around £191 per year, but this is a decision that companies will have to make following these changes.

What impact does the employment allowance have?

Many small businesses can claim the employment allowance that covers up to £5,000 of the employer’s class 1 NIC liabilities.

The allowance is available to businesses if their NICs bills were £100,000 or less in the previous tax year and where there are two or more employees on their payroll.

If this is available to set against the employer’s class 1 NIC on Director’s salaries, then the most tax-efficient means of extracting profits for these businesses is a salary equal to the personal allowance (£12,570), with their remaining income derived from dividends extracted from the company’s profits.

What is the optimum salary for directors in 2022/23 then?

Given the points covered above, it would seem that £11,908 is the optimum salary for most Directors unless they benefit from the employment allowance.

An annual salary of £11,908 would not be enough for most individuals to support their needs, especially with the current cost-of-living crisis, which is why earnings would need to be topped up with dividend payments that face lower tax and NI rates.

After paying a salary of £11,908, the first £2,662 worth of dividend income is tax-free (i.e., the annual personal allowance of £12,570, minus a salary of £11,908 plus the annual dividend allowance of £2,000).

This means that the first £14,570 earned by a Director is entirely tax-free. Any dividend income above this will then be taxed at the appropriate rate, for example, the next £35,700 of dividends will be taxed at 8.75 per cent, bringing the individual up to the basic marginal rate of £50,270 (2022/23).

Income above this will see dividend tax rates rise to 33.75 per cent for higher rate taxpayers and 39.35 per cent for additional rate taxpayers.

As you can see, the setting of tax-efficient salaries and other remuneration for directors can be challenging. For support with related matters, please contact our experts today.

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