The introduction the employment allowance has added another dimension to remuneration planning for one-man companies. With an increase in the personal allowance, we consider the optimal salary for 2015/2016.
Remuneration Planning The employment allowance (EA) gives employers a discount of up to £2,000 on their secondary Class 1 NI bill. The allowance must be claimed and is equal to the lower of £2,000 and the employers secondary Class 1 NI bill for the year. The EA adds a further variable to the salary v dividend debate for one-man companies. However, in order to determine the optimal salary level it’s also necessary to consider what other income, if any, the director receives during the year.
No Other Income? Salary equal to personal allowance. If the director shareholder has no other income and the EA is available, the optimum position will be to take a salary equal to the personal allowance (£883.33 per month) and to withdraw further profits in the form of dividends. Although this approach will result in the director paying some employees’ (primary) Class 1 NI, the NI bill will be outweighed by the corporation tax deduction in respect of the additional salary. As long as the director remains a basic rate taxpayer, i.e. net dividends of no more than £28,606 for the year, no actual tax will be payable in respect of the dividends as the liability is exactly matched by the associated tax credit.
Example 1. James decides to pay himself a salary for 2015/16 equal to his personal allowance of £10,600. By paying a salary in excess of the primary threshold (PT) which is £155 per week for 2015/16, Tim must pay Class 1 NI of £304.80 (12% (£10,600 – £8,060)), his corporation tax bill is reduced by £508 as a result of the corporation tax deduction on the salary in excess of the PT (20% (£10,600 – £8,060)). This generates an overall saving of £203.20 (£508 -£304.80). The employers’ NI of £343.34 (13.8% (10,600 -£8,112)) that would otherwise arise is fully offset by the EA. The remainder of the EA of £1,656.66 (£2,000 – £343.34) is lost.
Why not make full use of the EA? The EA of £2,000 is equal to employers NI on earnings of £14,493 in excess of the secondary NI threshold. However, while paying a salary of £22,605 (£14,493 + £8,112) would fully utilise the EA, this is not a worthwhile strategy as the associated primary Class 1 NI £1,745.40 (12% (£22,605 – £8,060)) and tax of £2,401 (20% (£22,605 – £10,600)), totalling £4,146.40, exceeds the corporation tax deduction of £2,909 (20% (£22,605 – £8,060)) on the salary paid in excess of the PT. Consequently it’s better to pay a salary equal to the personal allowance and lose part of the EA than to pay a higher salary to utilise the EA in full. In addition a company with up to five director shareholders and no other employees can pay each director a salary up to the personal allowance and still make use of the EA (the NI saving per director is £343.34 so five times this is £1,716.70).
Other Income Salary at least equal to LEL. If the EA is available but the director shareholder has other income (excluding dividends), such as rental income, it may only be beneficial to pay a salary to such a level as is necessary to preserve the director’s contribution record. The optimal result will depend on the director s personal circumstances. However, to maintain the contributions record, the salary must be at least equal to the lower earnings limit, which is set at £112 per week for 2015/16. This equates to a minimum salary of £5,824 for 2015/16. The extent to which it is advantageous to pay a higher salary will depend on whether the director has any of their personal allowance available. If the personal allowance has not been fully used, the optimal salary would be £10,600 less the additional income, subject to paying a minimum salary of £5,824. This is because the benefit of the personal allowance is lost when set against dividends, as the dividend tax credit cannot be reclaimed.
Example 2. Jose is a director of a one-man company. He receives rental income of £1,000 each year. For 2015/16 his optimal salary is £9,600. This is equal to the remainder of his personal allowance after taking account of the rent.
Example 3. Gareth is also the director of a one-man company. He has rental income of £15,000 in 2015/16. The rental income fully utilises his personal allowance. For the year to be a qualifying year for contribution purposes, Gareth will need to pay a salary of £5,824 for 2015/16. Beyond this level it is likely to be preferable to withdraw profits as dividends. If Gareth has sufficient qualifying years for state pension purposes or is above pensionable age, it may be preferable to withdraw profits as dividends rather than paying a small salary.This is to save having to pay personal tax on the salary, although as this is deductible for corporation tax purposes the net tax position is the same.
Rent rather than Salary? Where the business is based at home, a better option is to pay a salary equal to the primary threshold and for the company to pay rent to the director equal to the difference between the personal allowance and primary threshold, i.e. a salary of £8,060 and rent of £2,540. The director’s personal allowance is set against the salary and the rent, so no tax is payable. Additional profits should be withdrawn as dividends. The rent and salary are deductible for corporation tax purposes. No NI is due on the salary as it is does not exceed the PT and, unlike salary, there’s no NI on rent. If the director has loaned money to the company, interest could be paid instead of, or as well as, rent. To avoid a challenge the rent paid should be reasonable and in line with market rates.
If the director shareholder has no other income, the optimal salary for 2015/2016 is £883.33 per month (£10,600 per annum). However where the director has other income which uses up their personal allowance, a minimum salary of £5,847 per annum will ensure they maintain their NI record.