Salary vs Dividends For Business Owners in 2022/23
Over the past 6 or 7 months there have been a couple of announcements relating to National Insurance Contributions (NICs) which may leave business owners wondering how much salary they should be paying themselves (and whether to take dividends instead).
Recap of Recent Tax Changes
Last September the PM announced the creation of a new tax; the ‘Health & Social Care Levy’ starting 6th April 2023. This is a 1.25% tax charge applicable to employees, employers and the self-employed on earnings subject to NICs.
For the current tax year (starting 6th April 2022), the levy will not be in place, but NIC rates (employee, employer and self-employed) will increase by 1.25%, before reducing again once replaced by the levy.
A key difference is that the new levy will apply to those over state pension age, unlike NICs which do not.
Income tax rates on dividends are also increasing by 1.25% from 6th April 2022.
Spring Budget
In the Spring budget the Chancellor announced an increase in the point at which individuals begin paying NICs, broadly aligning National Insurance bands with income tax ones.
The threshold for employees will increase from £190 pw to £242 pw from 6th July 2022 (13 weeks into the tax year). If you paid yourself these limits, you could draw a salary of £11,908 without paying employee NICs this tax year. The lower profits limit for the self employed will be increased to this amount (£11,908).
The point at which employer NICs are payable was not increased by the chancellor, staying at £175 pw (£9,100 p.a.) for the tax year.
Corporation Tax
As a reminder, the 2021 Spring Budget announced an increase in the main rate of Corporation Tax to 25% from 1st April 2023. Corporation Tax will remain at 19% prior to this. The small profits rate of tax will be reintroduced, keeping the 19% rate for companies with profits of less than £50,000 (with a marginal rate applied on profits between £50,000 and £250,000).
Impacts of Changes
The increase in the primary threshold will incentivise slightly increased salaries for business owners, as employee NICs will be incurred at higher levels.
Above this, the increase in NICs / the Health & Social Care Levy will disincentivise salary/bonus versus dividends, albeit slightly. This is because the increase applies to both employee AND employer rates, a 2.5% total increase, compared to the 1.25% increase in dividend tax rates.
The bigger impact will come in April 2023, when the increase in Corporation Tax will substantially increase the effective rate of tax on drawing dividends from a company, virtually equalising the effective rate of tax between salary and dividends for many. Dividends will remain significantly more tax efficient at the basic rate of tax however.
The table below shows the effective rate of tax on a business owner drawing £1 of trading profit personally. The rates are at the margin, on each additional £1 drawn within the respective tax bands. The effective rates of tax include the impact of Income Tax, employee and employer NICs (and the Health & Social Care Levy from April 2023) and Corporation Tax. The rates are those applicable above the primary threshold (assuming this salary would be drawn at a minimum).
It is important to note that above table considers the listed taxes only and is based on drawing current year trading profits. It does not consider any other sources of personal income. It does not include the potential loss of any benefits or allowances as the result of increased income.
Remuneration Planning 2022/23
For a business owner-director drawing a salary, the first £9,100 will completely tax free. The tax is (almost always) deductible for Corporation Tax and is below the thresholds for income tax and employer and employee NICs.
Salary above £9,100 will attract employer NICs at 15.05%. Earnings over the primary threshold, will incur both employee and employer NICs, giving an effective rate of 24.6%.
For most business owner-directors, it will make sense to draw a salary of between £11,908 (within the primary threshold for NICs) and £12,570 (the personal allowance for income tax) in the 2022/23 tax year. It is very marginal between these two points – the precise most tax efficient level will depend on total income, including from other sources.
Above this amount it will usually be more tax efficient to pay dividends, rather than salary. As the above table shows, the effective rate of tax on drawing dividends at basic rate tax is 26.1% this tax year, compared to 42% for salary/bonus.
Once earnings exceed the basic rate, the effective rate of tax on dividends increases sharpy from 26.1% to 46.3%. The basic rate tax band is £37,700, meaning that income can total £50,270 before higher rate tax is incurred (i.e. £37,700 added to the £12,570 personal allowance).
It is also worth noting that if total income exceeds £100,000, then your personal allowance will be reduced by £1 for every £2 income exceeds £100k. This can create very high effective rates of tax on earnings between £100k and £125k, as the allowance is lost.
Example of business owner drawings within basic rate*:
Example of business owner drawings to retain personal allowance*:
* Assuming no other income
Pension contributions can be very effective form of profit extraction, particularly for trading profits available which would otherwise take a business owner over £100k of income if drawn. By making employer pension contributions, funds can be moved into your personal name with no initial tax liability - personal or on the company (1) - and also into an environment which is Inheritance Tax free (2). For more on this subject, please see our Business Owner’s Guide to Pension Funding.
If you would like to further discuss remuneration and profit extraction from your business, please do get in touch and we will see if we can help.
(1) assuming the contribution can be justified as part of the remuneration package, which is usually the case for business owner directors
(2) assuming death benefits are paid within 2 years of death
Disclaimer
The above is provided for general information only. No action should be taken without seeking advice for your specific circumstances. Collingbourne Wealth Management does not provide tax advice. All information is based on our understanding of current tax rules as at the time of writing, which can is subject to change.
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