Tax-efficient remuneration planning requires guesswork about your other income and outgoings. If your projections are off, you might end up with a higher tax bill than anticipated. How can you make your remuneration strategy more tax efficient?
Optimum salary
Tax planning for director shareholders typically starts with setting the level of salary. Usually the advice is to start with a salary of no more than the NI earnings threshold and then add dividends or low-tax perks to arrive at the most tax-efficient level of income. In practice you also need to take account of income from other sources, e.g. rents and profits from trade, and any tax relief for outgoings such as pension contributions. This can be difficult to predict accurately.
The other income factor
Unlike the salary and dividends you take from your company, the amount of other income you receive you have less control over. Therefore, you should view income from your company as the variable rather than following the crowd with a salary set at the NI threshold. Once you’ve taken salary (or dividends), say monthly, as the tax year progresses your other income (which isn’t under your control) might push you unintentionally into higher rates of tax. You can’t go back and undo salary or dividends you’ve taken.
Trap. When you take a salary of more than the NI lower limit of £6,396 per year you must report it for PAYE purposes to HMRC at the time, which means it has an up to date record of what’s been paid to you. And while you don’t have to report dividends there will be an audit trail in your company’s records or an entry on your bank statement, neither of which can legitimately be altered retrospectively.
Tip. Deferring your salary until the last month of the tax year will allow you take account of your other income to set the right level for tax efficiency.
Example. Fred is the sole director shareholder of Acom Ltd. He receives rental income of around £12,000 per year plus profits from freelance consultancy which draft accounts for 2022/23 show are £25,000. He has no other income or outgoings and therefore for 2022/23 his taxable income before salary from Acom is £37,000. The threshold at which higher rate tax applies is £50,270 (in England and Wales). By not taking his salary until March 2023 he can be sure that if he takes up to £9,100 it won’t trigger any higher rate tax. He can also take dividends of £4,170 and pay zero tax on £2,000 of these and just 8.75% on the remainder.
Directors’ NI
An important point to remember is that the secondary NI threshold, the salary level at which employers start to pay NI (£9,100 for 2022/23) applies to directors’ NI contributions annually instead of weekly or monthly as it does for employees. If an employee is paid more than £702 (£8,424/12) for a month, employers’ and employees’ NI is payable on the excess. This means you can pay a whole year’s salary in one month with the same NI result as if you had paid it gradually over the year.
Tip. If you need cash earlier in the tax year you can borrow from your company and repay the loan when your salary and dividends are paid. The loan might result in a tax bill as it counts as a perk, but it will be minimal.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.