Many large company owners prefer to extract cash in the form of dividends rather than salary payments because of the lower income tax rate liabilities and the lack of National Insurance obligations.
For smaller businesses, however, it is typically better to make salary payments equal to the national insurance earnings threshold of the employee (currently £8,060 for 2016/17). These payments will be tax-free for the company director since employee’s national insurance does not incur income tax.
In addition, salary extractions are considered tax deductible expenses for companies, which result in corporation tax savings of £1,612 (£8,060 x 20%)—meaning that small salaries can actually produce tax returns for the company.
Lastly, as long as salary payments are under the national insurance earning threshold, companies are not required to pay Employer’s NIC.
Ideal Salaries for all Business Owners?
Because each company’s circumstances and profits are unique, it is difficult to determine an optimal salary that will work for all company owners; however, there are certain recommendations that you can follow.
In many cases, a company owner salary of £8,000 is a good goal since it will typically save you from national insurance and income tax liability. This is because this salary is still under the national insurance earnings threshold of £8,060 (the cut-off for both employer’s and employee’s national insurance) as well as bellow the income tax threshold of £11,000.
For these reasons, a salary of £8,000 can help you avoid all three of these taxes.
Of course, a director’s optimal salary depends on several other factors as well, including the amount of income that they are receiving from other sources and the amount of cash that is being extracted from the company. However, for the average business owner, and for the purposes of this guide, £8,000 is an ideal round-number salary that is popular for its tax saving potential.