Starting a limited company is often a sensible choice for self-employed workers, but it can present you with a lot of things to get your head around.
One of the differences between being paid by an employer and running your own business is having to sort out your own pay. You can do this by taking a salary from your limited company – in the same way as a regular employee.
Why take a salary?
There are two main reasons to take a salary from your limited company:
- It’s counted as an expense, which means it lowers the amount of Corporation Tax you’re due to pay
- If the salary is above the Lower Earnings Limit (£6,032 in 2018/19 – view current tax rates) you accrue qualifying years towards your state pension.
High or low salary?
Why would I want to take a low salary?
As a UK taxpayer in 2018/19, you’ll have a personal allowance of £11,850. This means you can earn this much each year without paying income tax.
There’s also a National Insurance Contribution (NIC) threshold, but this is set at a slightly lower level before you start incurring a charge.
Under current rules, ‘office holders’ (ie. people who hold a position at a company but don’t have a contract, or receive regular salary payments) aren’t subject to the National Minimum Wage Regulations unless there‘s a contract of employment in place. A very low salary can be paid which means you do not pay NIC.
In 2018/19, if your salary is above the NIC ‘Lower Earnings Limit’ (£6,032) but below the NIC ‘Primary Threshold’ (£8,424) you don’t pay NIC, but you do retain your State Pension contribution record. Win, win!
Why would I want to take a higher salary?
There are some disadvantages to taking a very low salary, such as:
- Reduced maternity benefits. Technically, to qualify for maternity benefits, you need to be “employed” and thus be compliant with the National Minimum Wage Regulations
- You could miss out on part of your annual tax-free allowance if your salary is paid at the NIC Threshold (ensure you understand the impact of the total amount of salary and dividends you take from your company and other sources of income on your available tax-free personal allowance)
- Reduced cover under permanent health, critical illness, personal accident or similar policies for which benefits are calculated by reference to earnings
- Issues with National Minimum Wage Regulations if you want to have a Contract of Employment
- A high salary can benefit you when trying to obtain a financial reference.
Paying yourself in dividends
If your company makes a profit, which it hopefully will, then you have two options for what you can do with it. You can either reinvest it into the company or take it out and pay the shareholders. This payment is called the dividend payment.
The term “shareholder” simply refers to the owner(s) of the company. So, if you own and manage your limited company, you can pay yourself via a dividend. This can be a particularly tax efficient method of self-payment.
Through combining dividend payments with a salary, you can ensure that you’re at optimum tax efficiency. You can find out more about dividends in our “What are they and what taxes do I pay on them?” article.
Tax implications of taking a salary
As with regular full-time employees, all salaries will be subject to tax via Pay-as-you-earn (PAYE).
With three separate PAYE ‘taxes’, the benefit of reducing your Corporation Tax can soon be outweighed.
Income tax is cumulative for all employment earnings during the tax year.
For example, if you’ve already earned £10,000 from any employment in a given tax year, your personal tax-free allowance will be reduced by this amount.
Employee National Insurance Contributions
Unlike income tax, employee National Insurance Contributions (NICs) aren’t cumulative. This means each new employment has a separate earnings threshold before NICs are due. For employees who are higher rate taxpayers, there’s a maximum amount of NICs that can be paid.
If you’re an employee (but not a director), this threshold is set as a monthly amount. If you’re paid over this amount in any given month, you’ll have to pay NICs even if your pay for the rest of the year is reduced.
Directors have an annual threshold, which is 52 times the weekly threshold amount. When salary starts to go over this, they pay NICs.
Employer National Insurance Contributions
The threshold for employer NICs works in the same way as employees. For every salary amount your employee earns above the weekly National Insurance earnings threshold, the employer has to pay NICs. This represents another PAYE tax that the company has to pay.
Read more about current tax rates
Putting it all together
Taking all the above taxes together, it’s usually tax-efficient for most people to take a salary up to the Primary National Insurance threshold (£8,424 in 2018/19).
As the Lower Earnings Limit is lower than the Primary National Insurance threshold, you’ll still accrue qualifying years for the state pension.
No Income Tax to pay on salary up to the Primary National Insurance threshold
If you take a salary up to the Primary National Insurance threshold, you won’t pay any income tax on it if that is your only source of income. You can, however, pay yourself as much or as little salary as you wish. If you want to pay yourself more, you’ll need to use our Payroll service as the PAYE taxes on your salary will need to be calculated and filed on a monthly basis via HMRC’s Real Time Information (RTI) filing system.
You can use an external payroll service, but you will be responsible for calculating the correct PAYE and filing the returns with HMRC.
If you’re a Crunch client and wish to take more than the recommended salary amount, please contact your Client Manager.
What’s the most tax efficient?
It really is for you to decide – there isn’t a salary which is best for everybody. However, if you do want to pay yourself at the National Minimum Wage, if you’re aged 25 or over, this is going to be a salary of approximately £15,064 per annum (£7.83 x 52 x say 37 hours).
Some Visa references may require a higher level of salary – this should be ascertained before you pay yourself, as the net pay should tie up to the amounts shown on your bank statements.