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Taxation of Director's Salary and Dividends for 2016/17

Following changes to the personal tax allowance, Employment Allowance and the taxation of dividends from 6 April 2016 this article explores the key issue of the optimum level of director's salary and dividends under various circumstances.

Summary of key tax changes for 2016/17

  • Personal tax allowance increased to £11,000 and higher rate threshold to £43,000

  • NIC Employment Allowance increased from £2,000 to £3,000 but is no longer available to companies where a director is the sole employee

  • The dividend tax credit has been abolished with the actual cash amount of dividends received now being taxable. Dividends continue to be taxed as the ‘top slice’ of income

  • For basic rate taxpayers the rate of tax on dividends is increased from an effective 0% to 7.5%. For ‘higher rate’ taxpayers the rate is now 32.5% up to £150,000 total income and 38.1% above.

  • A tax free dividend allowance has been introduced which provides a 0% rate of tax on the first £5,000 of dividends per annum.

  • A savings allowance has been introduced which provides a 0% tax rate on non-ISA interest etc of £1,000 for basic rate taxpayers (£500 for higher rate taxpayers).

Optimum Salary Level

Where the Employment Allowance is not available then the optimum annual salary is £8,060 which results in nil National Insurance Contributions (NIC) but the director maintains a track record of contributions for the purpose of future entitlement to state benefits and pension.

A very small overall tax saving can be achieved by increasing the salary to £8,112 (the employee’s NIC threshold). However it is considered that the admin bother of having then to account for a modest amount of employer's NIC to HMRC outweighs the small increase in spendable income.

In those cases where the Employment Allowance is available then a salary of £11,000 equal to the personal tax allowance is considered to be the optimum amount as the overall corporation tax saving outweighs the amount of employee's NIC triggered.

Avoiding Higher Rate

Assuming a salary of £8,060 this means that £34,940 of dividends can then be extracted from the company by the director/shareholder but avoid any higher rate tax. This results in £40,975 of spendable income and an effective income tax rate of only 4.7% calculated as follows:

 

£

£

 Gross salary

8,060 

 

 Dividends

34,940 

 

 Total income

43,000 

43,000 

 PA

-11,000 

 

 Taxable income (all dividends)

32,000 

 

 Income tax charge:

 

 

 First £5,000 @ 0%


 Balance £27,000 @7.5%

2,025 

-2,025 

 Net spendable income


£40,975 

For companies where husband and wife or civil partners are both full-time working directors and equal shareholders this means that £86,000 of combined income can be extracted from the company at a very modest personal tax cost of £4,050. Of course it should be borne in mind that only the gross salaries are tax deductible for corporation tax purpose and that the company must have sufficient post-tax profits which allow this level of distribution.

Avoiding penal marginal tax rates

The potential for director/shareholders to have flexibility over the amount and timing of salaries and dividends (remember no longer grossed-up for tax purposes) extracted from their company can also be very tax efficient in terms of:

  • Reducing total annual income below £60,000 thereby minimising the High Income Child Benefit charge. To avoid any claw-back completely total income must not exceed £50,000.

  • Reducing total income between £100,000 and £122,000 thereby minimising the amount of potentially lost personal allowance.

  • Reducing total income to below £150,000 thereby eliminating the special higher rate applicable to dividends of 38.1% (or 45% on non-dividend income).

2016 AUTUMN STATEMENT

Please note that the above article is subject to any changes announced in the 2016 Autumn Statement which the Chancellor of the Exchequer will present on Wednesday 23 November 2016.

A summary of all the key announcements from the Autumn Statement will be available to view on our website from 9am on 24 November 2016 at www.marshvision.com