At the beginning of every new tax year, we calculate the optimum director’s fee for the owner of an Owner Managed Business.
The optimum directors salary in the 2021/22 tax year will be £8,840 per annum, which equates to £736 per month or £170 per week. This is the most tax efficient amount for the majority of directors to pay themselves.
Owner managed businesses can typically decide how to pay themselves. This can be either a salary, dividends or a mixture of them both. Directors, who have no other income should look to pay themselves the optimum directors salary of £8,840. Any additional income should be paid as dividends.
How do we calculate the optimum directors salary 2021/22?
The optimum directors salary 2021/22 is £8,840 per annum. The reason for this is all down to the National Insurance (NI) rates.
The lower earnings limit for NI in 2021/22 is £6,240 per annum. If a director earns over this amount it will count as a qualifying year for their future state pension.
The secondary earnings limit for NI in 2021/22 is £8,840 per annum. If the director’s annual salary exceeds this amount the director(their company) will need to pay NI contributions.
Therefore paying up to the secondary threshold of £8,840 but not a penny more, means the director qualifies for the state pension but does not need to pay any contributions.
Why not pay no salary at all?
A company can pay a director (who is also a shareholder) through either salaries or dividends.
A salary paid is a tax deductible expense. The company can deduct tax at 19%, which is the current company tax rate.
A dividend paid is not a tax deductible expense for the company.
Therefore paying a salary of £8,840 to the director saves corporation tax of £1,679. There is no such saving if dividends are paid.
Also, by paying a salary of £8,840 you are ensuring another qualifying year for the state pension is added.
When no salary is advisable?
The optimum directors salary 2021/22 should be £8,840 per annum only if the director has tax allowances available.
In situations, where the director has other income such as pension income, another salary, rental income, it may be advisable not to pay any salary at all. This would also apply if the director is already at pension age and it is no longer important to have another qualifying year.
Why not pay a higher salaries?
All taxpayers have personal allowances in which they can earn income tax free. As soon as these allowances are used up tax rates are applied.
When income exceeds £8,840 per annum, NI taxes are applied. Also, when the income exceeds £12,570 income taxes are applied.
The NI and income tax rates combined are significantly higher than the dividend tax rate. Even when accounting for the corporation tax reduction on the salaries, paying dividends is still more tax efficient.
When to pay more than the optimum directors salary?
In some certain circumstances it may be advisable to pay in excess of the optimum directors salary.
Should the director have a contract of service they must legally be paid the national minimum hourly wage. This would typically be higher than the £8,840 per annum.
Dividends can only be paid out if the company has profit and loss reserves. If the company has made losses in the past it may not be possible to pay dividends. Higher salaries may be the only option.
What was the optimum directors salary in 2020/21?
Every year the income tax and NI rates change. As a consequence the optimum directors salary changes every tax year.
The optimum directors salary in 2020/21 was £8,788.
How to optimise salary and dividends for directors in 2021/22?
When income exceeds £8,840, dividends are more tax efficient than additional salaries. This is because the dividend tax rates are lower than PAYE & NI tax rates.
Clearly an annual salary of £8,840 is not high enough for most of our clients to live off. The additional income is then paid to the director as dividends. We are assuming the director is also a shareholder.
After paying a salary of £8,840, the first £5,730 worth of dividends are tax free. (Calculation: Personal allowance of £12,570 less salary of £8,840 plus the dividend allowance of £2,000).
The director has therefore now earned £14,570 all of which is completely tax free.
The next £35,700 of dividends are taxed at 7.5%. This takes us up to the top level of basic rate, which is £50,270 for 2021/22.
Dividend tax rates for higher rate taxpayers are taxed at 32.5% and for additional rate taxpayers it is 38.1%.
Conclusion – optimum directors salary 2021/22
The majority of owner managed businesses should pay themselves a salary of £8,840. We then recommend additional income is paid as dividends.
The salary of £8,840 will save the company corporation tax of £1,679.
A director who earns £50,270 through a combination of salary and dividends will pay personal taxes of £2,677. This is therefore an effective tax rate on the £50,270 income of just over 5%.
SRC-Time are one of the South East’s leading accountancy firms in advising on all aspects of business, taxation and corporate finance and we can assist in any issue raised above.
Our expert team is available to provide you with advice and can be contacted on 01273 326 556 or you can drop us an email at email@example.com or speak with an account manager to get any process started.