£8164 p.a. is optimum directors’ salary for 2017/2018

28th April 2017

Changes to the taxation of dividends and ongoing ambiguity over directors’ employment allowances mean that the efficient management of income for directors and business owners has become increasingly complex. Knowing how to work within NIC thresholds to ensure tax-efficient, optimum director salaries is an important consideration. We break down what you should be taking into consideration for your Director salaries this year.

The traditional approach for director income

Taking a low basic salary with the balance of income being paid as dividends has been a common approach for directors and business owners of limited companies. It gives good tax efficiency, both for the business and the individual director, and is based on the following common practice:

  • The director takes a low salary, no higher than the personal allowance. This means that it does not attract personal tax.
  • The salary is set high enough for national insurance purposes i.e. that it counts as a years ‘stamp’ for national insurance history. This helps to protect future entitlement to state pension and benefits.
  • The salary is a tax-deductible expense for the business. This means that corporation tax is saved at 20% on the gross salary.
  • Further income is paid as dividends, which do not attract national insurance and, therefore, mean the director is not paying any more NIC contributions than they need to.

However, recent changes to the taxation of corporate dividends mean that the tax benefits of income paid through dividends have decreased. Dividends can certainly still offer tax-efficient income, depending on individual circumstances, but increased consideration should be given to ensuring efficient salary payments for directors.

What do I need to know about director salaries?

An efficient director salary aims to stay between two National Insurance thresholds:

  • The Lower Earnings Limit – The aim is to sit above this. If you earn above this limit then you have protected your entitlement to future state pension and benefits, but without necessarily paying any National Insurance.
  • The Primary Threshold – The aim is to sit below this. If you earn above this you have to start paying National Insurance.

So, the objective of efficient director salaries is to pay above the Lower Earnings Limit but to remain below the Primary Threshold.

What is the NIC Primary Threshold for 2017/2018?

The threshold is £8164 for this financial year.

Consideration of The Employment Allowance

It is possible that your company is entitled to the Employment Allowance. Introduced in 2014, the Allowance covers the first £3,000 of Employer National Insurance contributions which need to be paid within the tax year. In some cases, it may be that it is more efficient to pay a slightly higher director salary until such point as the NIC Employment Allowance has been utilised. However, this is very much dependent on circumstances of both the company and the individual and there are specific restrictions on when it may apply. For example, you can’t claim if:

  • You’re the director and only paid employee in your company
  • You employ someone for personal, household or domestic work (e.g. a nanny or gardener) – unless they’re a care or support worker
  • You’re a public body or business doing more than half your work in the public sector (e.g. local councils and NHS services) – unless you’re a charity
  • You’re a service company with only deemed payments of employment income under ‘IR35 rules

Some examples

Example One: Company pays director £8164 salary and £36,836 dividends.  Company pays tax at 19%.

  • Income tax suffered by director is £2137.50. No tax is suffered on the salary as it is covered by the individual’s Personal Allowance of £11,500.  Tax of £2,137.50 is suffered on the dividends received.
  • Employees and employers national insurance = nil.
  • Cash received by the director = £42,862.50
  • Cost to the company = £45,000 less 19% corporation tax relief on the salary = £43,448.84

However, the above analysis ignores the fact that there is now a £3,000 Employers’ NIC Allowance. Many small family companies have no employees and so this £3,000 allowance would be available to utilise against the directors’ salaries, provided that there is more than one director in paid employment within the company. This is addressed in example two. The amount of dividends is selected to keep the cost to the company the same as with example one. This way, the tax savings all go to the individual.

 Example Two: Company pays director £11,500 salary and £33,500 dividends.  Company pays tax at 19%.  Company has no employees, but other paid directors.

  • Income tax suffered by director is £2,137.50. No tax is suffered on the salary as it is covered by the individual’s Personal Allowance.  Tax of £2,137.50 is suffered on the dividends received.
  • Employers’ national insurance = nil as it is covered by the £3,000 allowance.
  • Employees’ national insurance = £400.32
  • Cash received by the director = £42,462.18 i.e. a decrease of £400.32 on example one.
  • Cost to the company = £45,000 less 19% corporation tax relief on the salary = £42,815 – a decrease of £633.84 on example one, giving an overall saving of £233.52 compared to example one.

If there are no employees other than several directors, then the above could be repeated seven times. Once there are more than seven directors (or employees) earning £11,500, the £3,000 Employers’ NIC Allowance will be fully utilised.  Therefore in a typical husband and wife type company with no employees, the saving in 2017/18 from applying this strategy would be £467.04. If there were two children who were also directors, the savings would be £934.08.

However, if the company has one employee earning £29,903, the £3,000 Employers’ NIC Allowance is already fully utilised and so the most tax efficient owner/director’s salary would revert to £8,164. Example three demonstrates this. Again, the dividends have been varied to keep the cost to the company the same so that the individual gets the tax benefit, or in this case to clarify that more tax/NIC is suffered as a result of the salary increase.

 Example Three: Company pays director £11,500 salary and £33,500 dividends. Company pays tax at 19%. The company has several employees and the £3,000 Employers’ NIC Allowance is already utilised.

  • Income tax suffered by the director is £2,137.50 . Again, no tax is suffered on the salary, but does arise on the dividends paid.
  • Employers’ NIC = £460.37
  • Employees’ national insurance = £400.32
  • Cash received by the director = £42,462.18
  • Cost to the company = £45,000 + employers’ NIC of £460.37 less corporation tax saved of £2,272 on the salary gross of employers’ NIC, making a net cost of £43,187.90.

 Other factors to consider

  • Some directors wish to avoid paying higher rate tax and so take a combination of dividends and salary that keeps them just below the higher rate band. In these situations, if salaries are increased to utilise the new £3,000 employers’ NIC threshold, dividends may need to be reduced accordingly.
  • Please note that if the company has one employee earning £29,903, the £3,000 employers’ NIC allowance is already fully utilised and so the most tax efficient owner/director’s salary would revert to £8164. Clearly, thought needs to be given to each company situation.

If you would like information about efficient income management, or any other tax issue, please do not hesitate to give our friendly tax team a call.

*all information correct at time of distribution April 2017

vikki.ashton@ttrbarnes.com 0191 567 0304

Vikki Ashton

Chartered Accountants in Sunderland, offering expertise on everything from Tax and Business Planning,
to Accounts and VAT.