Best combination for salary and dividends in 2019/20

Ahead of the new tax year, in this blog we discuss the best combination for salary and dividends in the 2019/20 tax year.

Salary and dividends in 2019/20: What are your options?

As a limited company owner, I'm sure you're aware that the best way of taking money from your company is a combination of salary and dividends. So with the new tax bands having been announced, what combination of salary and dividends in 2019/20 will be most tax effective for you?

Please note that this blog assumes you are not a Scottish tax payer because Scotland has different rates of income tax for non-savings income (eg salary).

Salary and dividends in 2019/20: New tax rates

The personal allowance for 2019/20 has increased to £12,500 (2018/19 £11,850). The basic rate threshold has increased to £50,000 (2018/19 £46,350).

The dividend allowance remains at £2,000.

You can find details about all the 2019/20 tax rates on HMRC's website.

In the 2019/20 tax year, any dividend in excess of the £2,000 allowance will be taxed as follows:

You won't pay any tax if you have unused personal allowance which covers your additional dividend
Any dividends in the basic rate tax band (up to £50,000) will be taxed at 7.5%
Dividends in excess of the basic rate tax band will be taxed at 32.5%
Any dividends falling within the additional rate band (income above £150,000 for 2019/20) will be taxed at 38.1%

Salary and dividends in 2019/20: Low salary, high dividends

Most owner managed businesses take a low salary and a higher dividend because this is the most tax effective combination for salary and dividends in 2019/20. The strategy works as follows:

You take a salary between the minimum level because this triggers a national insurance record for your state pension and the personal allowance level
Your company can claim the the cost of your salary when it calculates its corporation tax. As a result it will save corporation tax at 19% on any salary taken.
You take any further money from the company as dividends. Remember that dividends are declared after tax so the company doesn't save corporation tax on any dividends taken. Also note the following points:
You can take dividends up to the level of post-tax profit available in the company ie the total of your current year's post-tax profit and any retained profits brought forward
National Insurance isn't paid on dividends
The company doesn't have to pay out all available profits at one time - meaning dividends can be managed to minimise your personal tax liability

Shareholders in owner managed businesses normally choose one of two strategies - taking a salary at the minimum level to trigger a national insurance record for your state pension or taking a salary at the personal allowance level.

If you run your business with you're spouse and you're both taking a salary, you may want to adopt the second strategy because you can claim the employment allowance.

Salary and dividends in 2019/20: Strategy 1

Salary at the NI primary threshold

If you can't claim the employment allowance or you aren't good at administration, then this may be the strategy you prefer to take.

National Insurance limits:

Lower earnings limit: you need to earn above this limit to protect your entitlement to the state pension. You won't necessarily have to pay any NI at this limit. This is £6,136 for the 2019/20 tax year.
Primary threshold: if you earn above this limit you will start paying National Insurance. This threshold is £8,632 for the 2019/20 tax year.

We recommend you pay yourself a salary at the primary threshold ie £8,632.

You could then draw dividends up to £41,368 without having to pay any higher rate tax (basic rate band of £50,000 less salary of £8,632).

At this level of dividends you will have basic rate tax to pay of £2,663 calculated as follows:

Nil tax up to personal allowance of £12,500 (used £8,632 for salary and £3,868 for dividends)
Nil tax for dividends at £2,000 due to the dividend allowance
£35,500 (£41,368 less £3,868 less £2,000) dividends taxable at 7.5% - £2,663

You will have £47,337 (£50,000 less £2,663) in your pocket after tax.

The company will also save corporation tax of £1,640 (£8,632 * 19%) with this strategy.

Salary and dividends in 2019/20: Strategy 2

Paying salary to utilise the employment allowance

This option won't be available if you're the company's sole director and the only person on the payroll.

This approach also won't be effective if the employment allowance has already been utilised against the NI due on the salaries paid to your company's other employees.

However if you do have surplus employment allowance available we recommend you pay yourself a salary up to the personal allowance of £12,500.

You could then draw dividends up to £37,500 without having to pay any higher rate tax (basic rate band of £50,000 less salary of £12,500).

With this strategy, there will be £3158 basic rate tax and Employee's national insurance to pay. You can see how this is calculated below:

Employer's National Insurance - £495 (being £12,500 less Primary Threshold (£8,632) = £3,868 *13.8%) . However in this example we're assuming that this is covered by the employment allowance.
Personal allowance - £12,500 all used against salary
Nil tax for dividends at £2,000 due to the dividend allowance
£35,500 (£37,500 less £2,000) dividends taxable at 7.5% - £2,663
Employee's national insurance payable on salary - £464 (£12,500 less £8,632 = £3,868 * 12% (assuming NI letter = A))

You will have £46,873 (£50,000 less £2,663 and £464) in your pocket after tax.

The company will also save corporation tax of £2,375 (£12,500 * 19%) with this strategy.