Optimal contractor salary for 2019-20

Published: 10 Mar 2020

Updated: 11 Mar 2020

 

Written by Ray Coman

 

2019-20-salary calculationAs 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

Employment allowance

Tax planning

 

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:

https://www.gov.uk/government/publications/employment-allowance-more-detailed-guidance/single-director-companies-and-employment-allowance-further-employer-guidance

 

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.

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