In this sample tip from the newly updated guide ‘101 Practical Tax Tips’, Sarah Bradford looks at the optimal salary when NIC employment allowance is not available.
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The maximum salary which can be paid free of tax and National Insurance depends on whether the National Insurance employment allowance is available to shelter any employer’s National Insurance liability that would arise on the payment of the salary.
The NIC employment allowance is not available where the sole employee is also a director. This is usually the case for a personal company.
Where the employment allowance is not available and the director is over the age of 21 (and none of the other upper secondary thresholds for employers apply), the maximum salary that can be paid free of tax and National Insurance for 2023/24 is one equal to the secondary threshold of £9,100. The personal allowance and primary threshold are set at the higher level of £12,570 for 2023/24. It should be remembered that directors have an annual earnings period for National Insurance purposes.
Although the maximum salary that can be paid without having to pay any National Insurance (employer’s or employee’s) is £9,100 – equal to the secondary threshold – the fact that the salary and employer’s National Insurance are deductible for corporation tax makes it worthwhile paying a salary equal to the primary threshold and personal allowance of £12,570 and paying employer’s National Insurance at 13.8% to the extent that the salary exceeds £9,100. The corporation tax deduction at between 19% and 25% outweighs the National Insurance cost on the higher salary at 13.8%.
However, once the salary level reaches the primary threshold of £12,570, a liability to employee’s National Insurance contributions and to tax arises. Employee contributions of 12% are payable to the extent that the salary exceeds £12,570, as well as employer contributions of 13.8%. The employee will also pay tax at 20% on the excess. The tax and National Insurance hit outweighs any corporation tax savings on a higher salary. Consequently, once the salary level reaches £12,570, it is worth extracting further profits as dividends.
Thus, the optimal salary for 2023/24 where the employment allowance is not available is one equal to the personal allowance and primary threshold of £12,570.
However, as there is some administration involved in paying the employer’s National Insurance over to HMRC, the decision may be made to forgo the small savings achieved by paying a salary of £12,570 and instead pay a salary of £9,100, which can be paid free of any National Insurance. This will save the associated administration. However, the administration burden can be minimised by having an annual PAYE scheme.
EXAMPLE: Optimal Salary Where NIC Employment Allowance Is Not Available
Helga is the director and sole employee of her personal company. As such her company is not entitled to claim the employment allowance. She is aged 42.
She wants to pay a salary for 2023/24 which is sufficient to ensure that the year is a qualifying year for state pension purposes and wants to know the level at which she should set her salary. For the year to be a qualifying year, she must pay a salary of at least £6,396 for 2023/24.
However, while the salary can be increased to £9,100 (the level of the secondary threshold for 2023/24 before any National Insurance is due, it will be beneficial to pay a salary equal to the primary threshold and personal allowance for 2023/24 of £12,570. While paying an additional £3,470 to increase the salary to £12,570 will incur an employer’s National Insurance liability of £478.86 (£3,470 @ 13.8%), the additional salary and associated National Insurance of £3,948.86 (£3,470 + 478.86) is deductible for corporation tax purposes, reducing the corporation tax bill by £750.28 if she pays corporation tax at the rate of 19% – a net tax saving of £271.42 (£750.28 – £478.86). If she pays corporation tax at a rate in excess of 19%, the corporation tax savings will be higher.
Once the salary exceeds the personal allowance and annual primary threshold of £12,570, employee National Insurance at 12% and tax at 20% are also payable in addition to employer’s National Insurance of 13.8%. Consequently, paying a salary in excess of £12,570 is not worthwhile as the tax and National Insurance (employee’s and employer’s) on the additional salary outweighs the corporation tax saving on the salary and employer’s National Insurance.
