As a company director, it’s vital to ensure that you’re efficiently paying yourself so as not to overspend on taxes. Indeed, in many cases, it’s easy for business owners to feel unsure about how they should pay themselves for the work they do. However, making a mistake with your director’s salary decisions can result in you paying substantially more taxes than you should be liable for.
Luckily, this doesn’t actually have to hold you back from making a good rate of pay, and there are several options you could consider to optimise your director salaries for the 2023/2024 tax year.
Why Taking a Salary is Complicated for Limited Company Directors
We all want to get the most from our work – but as a company director, you’ll likely need to think about this a little harder than most since there’s a lot to keep in mind. Indeed, while there’s nothing technically stopping a company director from taking out a salary, the reality is that this may not always be the most cost-effective approach to take.
Tax Implications for Salaried Directors in a Limited Company
Salaried directors face unique challenges when it comes to their taxable income. As such, this is something that is highly important to recognize when determining the most tax-efficient director salary structures in 2023/2024.
It is important to recognize that a limited company must pay two types of taxation – directly or indirectly – for a director’s salary. These are as follows:
- First threshold taxes: Initially, since the director is an employee of the limited company itself, they will pay standard National Insurance of salaried income.
- Second threshold taxes: As the employee, the director will pay National Insurance on their earnings. However, the limited company itself will also have to make employer’s National Insurance contributions.
In other words, a director’s salary is typically paid twice for the same income – and this can represent a significant challenge for many businesses and directors alike.
Of course, the different tax thresholds and categories will still apply to the income, and the tax band itself won’t change just because the company and the director both have to pay. However, the total tax paid on the income will effectively be doubled since both the company and the director have to pay tax on the salary.
Do Personal Allowances Work with a Director’s Salary?
In many cases, companies and directors end up paying significantly more in the way of taxes because they have optimised their earnings properly. However, one of the most effective – and simplest – options available to help streamline your business taxes is simply to focus on your personal allowance.
Indeed, every worker is entitled to a tax-free personal allowance of income – which is usually around £12,500 at present (though this varies annually, so make so you check the personal allowance before getting started). As a result of this, if your director’s salary is at or below this threshold, they won’t be liable to pay income tax.
Working out how much income tax your directors will have to pay from their salary is hugely important in many cases. However, this is very simple to do with a quick calculation; subtract the tax-free personal allowance from your director’s salary to determine how much of their income they must pay taxes on.
Paying Directors a Salary: Key Factors to Consider
If you have been thinking of paying your directors a regular salary, there are several things you should consider to ensure this is the most appropriate choice for your own needs. After all, paying your directors a salary can offer many great benefits, but it’s not always clear which options might be right for your specific needs.
With this thought in mind, there are several reasons you might want to pay your director by salary. Not only does this provide your directors with additional security, but a salaried pay structure also makes it easier for directors to take out loans. Moreover, a salaried position also allows the director to begin building up qualifying years towards state pension allowances; as a result, it’s undeniably helpful for many different reasons.
However, it’s well worth noting that salaries come with several potential drawbacks – most notably, they come with higher tax rates overall, which can be a severe blow to your director’s income overall. Indeed, especially for directors earning larger sums of money, taxes of 20% or more twice over can be painful to have to pay. And, with this thought in mind, it’s perhaps unsurprising that many businesses have looked for new ways to help offset some of the taxation involved with a company director’s salary.
Making the Most of Dividends
In many cases, the cost of paying tax twice on a salary can be hugely frustrating from both the employee’s and the employer’s perspectives. With this thought in mind, looking at other options – such as dividends – could really help.
Of course, you’ll need to offer your directors some form of official pay – they’re not there as volunteers! Nonetheless, paying your directors largely through dividends rather than paying them with a salary could be helpful. This can offer several key perks for both the director and the business:
- For the company: From the company’s perspective, dividend payments offer an excellent way to increase the stability of the business. This helps ensure that if your business has a bad year – it can happen to any of us – the firm doesn’t have to risk paying an unaffordable sum of money
- For the director: As a director, dividend payments can be much more cost-effective than having to pay tax as standard on your salary income. For one thing, if your dividends are paid as a percentage of your income, you’ll potentially be paid a variable figure based on how hard you work; if you put in the time, you can make more than your regular salary might offer. This is because you won’t necessarily be liable for national insurance contributions for your dividends, which helps to shave a significant sum of money off of your tax bill.
Remember: Dividends Aren’t Just Free Money!
It’s important to recognise that dividends don’t necessarily mean free money. Indeed, you may still be liable to pay some tax on your dividends, especially if they begin getting rather sizeable. However, if you need to reduce the amount of your director’s taxes – for example, if you are the director of the company yourself or if you know that they are trying to save up – paying through dividends could be an important option to consider overall.
What is the Most Tax-Efficient Strategy for Paying a Director’s Salary?
At this point, we’ve looked at some of the main things you need to know about paying a director’s salary. However, it’s important to remember that your director’s salary isn’t necessarily easy to work out if you’re trying to be efficient with taxes since there’s a lot at play here.
In fact, the salary you pay your director may be based on many different factors, and juggling these can seem like a headache. Nevertheless, by taking a little time to consider the available options and strategies and how these might work (or not!) for your business.
But remember: while you can absolutely work this out on your own, it’s also worth keeping in mind that every business is different. Accordingly, if you’re feeling unsure about the most tax-efficient strategy for your director’s salary and dividends, don’t hesitate to contact our friendly team today.
How Much Salary Should I Pay a Director?
First up, we need to address the basics: how much salary should you pay a director? Well, this question may not always be easy to answer, and there are a lot of factors that come into play. As a result, finding the right option can be tricky – which is where professional teams like ours here at LiderTax come in. Nonetheless, there are several ways to help optimise a director’s salary.
Now, the first thing we should point out here is that, since you are paying a director a salary, you don’t necessarily need to focus on minimum wage; that applies to hourly paid employees, instead. As such, you have much greater freedom with a salary to choose how much you will pay.
Looking at the Lower Earnings Limit
Now, you could pay your director less than the lower earnings threshold limit, but this doesn’t really offer any benefits.
Technically speaking, it does mean your director wouldn’t have to pay taxes on the income – but it also means they won’t start accruing National Insurance benefits. This includes qualifying payments towards a state pension, so this approach could leave your director out of pocket.
As such, to start building a tax-efficient approach, you’ll likely want to consider a salary that’s marginally higher than the lower earnings limit. This currently falls at £6396 per year. This approach helps build qualifying years towards a state pension for your director. You have quite a bit of freedom here, as your director won’t need to pay taxes on the earnings until they reach the primary threshold, which is currently around £12,570 for the year.
When a director takes a salary between the lower earnings limit and the primary threshold, they’ll simultaneously enjoy the benefits of national insurance without actually having to pay for the privilege. Ultimately, this will affect the total sum of money that an individual will receive as part of their state pension down the line.
Remember: an individual can earn up to £12,710 a year without paying tax on it through their tax-free personal allowance. This effectively means that the director only has to pay tax on income over this threshold. However, this does apply to all income cumulatively. So if the limited company director has an additional income, this may be already used up.
Ultimately, this means that directors taking a salary below the primary threshold (without over income putting it above) won’t have to pay tax or national insurance; nonetheless, they’re still being considered an employee of the business.
How Much Should I Pay a Director in Dividends?
Many directors take most of their income from dividends, which provides a much more tax-efficient process for most people. A dividend is simply a share of the company’s profits, paid out when the company performs well; if the company fails to make a profit in a particular financial year, the dividend isn’t paid out.
The main reason that dividends are preferred as a payment option is that they are subject to a much lower tax rate. However, dividends can also help encourage non-owner directors to put their all into the business too.
One of the key things to note about dividends is that they are still subject to tax rules. This means that if a director is paid in dividends, they will still pay tax on these to a degree. However, this is calculated at a different rate compared to regular income tax. For example, there is a tax-free dividend allowance, which can be used alongside a personal allowance.
How much a director takes in dividends will influence how much tax they pay. For basic rate dividend payments up to £50,270, the tax rate is only 8.75%. Meanwhile, directors earning more than £150,001 in dividends will pay 39.35% tax; however, this is still lower than the standard tax rate for the same bracket.
Does Having Multiple Directors Impact the Most Tax-Efficient Strategy?
If multiple company directors are getting paid a salary as part of the limited company model, you may want to consider claiming an employment allowance. The employment allowance is worth around £5000, so this can significantly benefit your business if you have been looking to develop a more profitable and stable income overall.
When Director Salaries are Backdated
A further complicating factor for your director’s salary is backdating payment. This occurs commonly if you are the company director personally and have delayed taking an income from the company until things are more established and running smoothly.
So, what’s the right approach to take for tax-efficient payments if your company director’s salary has been delayed? Well, if your director’s salary has been backdated, there’s some good news: this isn’t overly difficult to handle.
National Insurance thresholds are pro-rated based on the appointment date for your director, as opposed to salary payment dates. In line with this, in this particular scenario, you may want to pro-rate the director’s salary to when the company incorporated or the director’s starting date. So long as you remain within the same financial year (for example, the director started in May but wasn’t paid until July), you can still remain tax-efficient relatively easily.
Finding the Right Approach for your Limited Company Director’s Salary
If you’ve been looking for the most efficient options to pay yourself and your business directors, there are plenty of options you could consider overall. Of course, the most tax-efficient director payment method is to pay via low salaries and dividend payments. However, there are other options you may have also considered.
While there’s nothing saying you have to pay your directors in this manner, focusing on dividends for good performance is potentially a good way to reward your directors while simultaneously reducing taxation.
An important point to remember here is that company directors effectively pay tax twice on their earnings. Indeed, not only does the business have to pay tax on the income, but the director’s salary is also liable for tax. Ouch!
Fortunately, there are ways to work around this. Knowing where to begin isn’t always easy, though. As such, if you have been struggling to balance the books after paying so much in the way of tax, considering lower-tax options could definitely be a big boost. Fortunately, our friendly experts here at Lidertax may be able to assist with this challenge!
Take the challenge out of working out the most tax-efficient director’s salary for your business. Contact our friendly experts here at Lidertax today to learn more about our services and how we can assist with your limited company’s salary management.