Optimal contractor salary for 2019-20
Written by Ray Coman
As the end of the tax year approaches, the following calculations explain the optimal salary payments for companies with a sole director.
Employer's national insurance
A salary which is equal to the national insurance threshold of £719 is the most tax efficient. A higher salary would give rise to 13.8% national insurance.
For instance, if a salary were paid up to the personal allowance threshold for 2019-20, the additional salary would be £12,500 minus £8,628, or £3,872.
- Corporation tax saving on additional salary @19% = £735.68
- Employers’ national insurance @13.8% = -£534.36
- Corporation tax saving on employer’s NI as calculated above @ 19% = £101.52
- Employee’s national insurance at 12% = - £464.64
(There is a slight increase in dividend which is as follows:
- The reduction in corporation tax on salary would now be treated as dividend: £735.68
- The reduction in corporation tax on employers’ national insurance would now be treated as dividend: £101.53
- The employer’s NI would otherwise be treated as dividend: £534.34)
Net increase in income tax of £302.87 @ 7.5% or £22.72
Net tax cost = £184.52
The lower salary also spares the hassle (and exposure to late payment penalty) of having to make monthly PAYE payments.
Tax saving if paid as dividend rather than salary is £184.52.
Employment allowance
For contractors who subsequently hire staff, a higher salary could be beneficial.
Further information about this scenario can be found in point 14 of the guidance below:
Provided the £3,000 employment allowance is still intact (and not used up with salary payments to the employees) the tax savings are as follows:
- The additional salary would be £12,500 minus £8,628, or £3,872.
- Corporation tax saving on additional salary @19% = £735.68
- Employee’s national insurance at 12% = - £464.64
- (There is a slight increase in dividend which is as follows:
- The reduction in corporation tax on salary would now be treated as dividend: £735.68)
- Net increase in income tax of £735.68 @ 7.5% or £55.18
Net tax saving = £215.86
Tax planning
Careful director’s remuneration planning should consider:
- Optimal salary payments;
- Timing of dividend extraction;
- Use of proposed dividend to bring total income up to higher rate tax threshold;
- Pension contribution;
- Accumulation of retained profit for extraction as capital on eventual dissolution or sale of the business;
- Addition of family members with whom the owner shares household bills; and
- Investment in capital.
