Introduction to the budget changes

It's a new tax year and HMRC have updated some of the tax rates that impact payroll. This means that the optimal basic salary for directors has changed. This year is slightly different in that there is a further change coming part-way through the year (July 2022). We'll be covering both below.

Click here if you want to find out what the most tax efficient salary was for last year (2021/2022).

Summary of the new tax efficient salaries

• Sole director/employee companies: Basic Salary = £758.33/month
• Companies with more than one employee/director (before July 2022): Basic Salary = £823.33/month
• Companies with more than one employee/director (from July 2022): Basic Salary = £1,047.50/month

Tax efficient payroll: The basics  

In general, a combination of a small salary and dividends is the best way to go. The reason for this is that a basic salary incurs little to no national insurance contributions and is covered by your annual personal tax free allowance, whilst being a tax-deductible business expense for your company for corporation tax purposes. The balance of your income should then be covered by dividends. Learn more about dividends here.

Tax calculator for 2022/2023

To help illustrate the changes, we have put together an Excel model that will show you the underlying calculations to estimate your tax liability for a given salary and dividend level, depending on how many eligible employees your business has.

To download the calculator visit our Tax Calculator page.

Assumptions

When discussing the optimal basic salary for directors, this article assumes that you have no other income from other sources (e.g. employment, property or investment). The reason for this is that if you do, your tax free allowances may be being used elsewhere.

What salary should I pay myself in 2022/2023?

April, May and June 2022

Depending on whether or not you are eligible for the Employment Allowance (see below), the optimal salary to pay yourself is either to pay up to the Secondary Threshold (£758.33/month) or the Primary Threshold (£823.33/month). We will explain both of these thresholds and how they impact things below.

From July 2022

Due to planned tax changes the optimal salary for companies with more than one employee will change in July 2022 to £1,047.50/month. The changes do not impact those with one employee and so should remain the same (£758.33/month).

If you are a client of ours we will notify you in July to remind you of the change.

Employment Allowance (EA)

The Employment Allowance is an annual tax allowance that offsets the first £5,000 of an employers national insurance liability in a financial year. In order to qualify for the Employment Allowance you must meet the below criteria:

• Your total Employer’s Class 1 National Insurance liability was less than £100,000 in the prior tax year (2021/22)
• You must have at least two employees on the payroll scheme that earn above the secondary threshold (£992/month). Note - directors count as employees. Therefore if you only have two directors on the payroll your business will qualify for the Employment Allowance.

Please note that the allowance is not automatically applied and must be claimed when making each payroll submission.

Who does not qualify for Employment Allowance

You will not be eligible for the Employment Allowance if you do not meet the criteria outlined above. For example, if there is only one director on a payroll scheme. This is regardless of how much the director pays themselves.

Secondary Threshold Explained

The Secondary Threshold for national insurance purposes is currently £9,100/year (£758.33/month). It will not increase (unlike the primary threshold) from 6th July 2022.

Pay up until the Secondary Threshold does not incur any type of national insurance contributions.

Pay after the Secondary Threshold begins to incur employers national insurance. This is currently 15.05% of any amount above the Secondary Threshold.

For example, someone paid £9,100 per year incurs NIL employers national insurance contributions to their employer. Someone paid £9,500 incurs £60.20 (£9.500 minus £9,100 = £400 @ 15.05% = £60.20) in employers national insurance for their employer.

Why do solo director companies only pay to the Secondary Threshold?

If you are a sole director, you will not qualify for the Employer Allowance. Therefore, you do not want to incur employee or employer national insurance contributions as these will increase costs (plus the headache of remembering to make payment) to your business.

Because of this we recommend that businesses with only one employee (director) should pay themselves £758.33 per month.

Primary Threshold Explained

The Primary Threshold is slightly above the Secondary Threshold. At the start of the 2022/23 tax year the annual Primary Threshold is £9,880 (£823.33/month) and this increases to £12,570 (£1,047.50/month) from 6th July 2022.

Pay up until the primary threshold does not incur employee national insurance contributions. However, pay past this point does.

Employee national insurance contributions are deducted from an employees gross pay and are currently 13.25%.

As employee national insurance contributions are deducted from an employees' pay, they are not incurred by the employer, however, if you are a director in the company then this money is being deducted from the amount paid to you, which is why we do not recommend paying yourself above the Primary Threshold.

Note: For pay above £4,189 employees national insurance contributions are reduced to 3.25%, however, we will not cover this within this blog post.

Why pay to the Primary Threshold (£823.33 and then £1,047.50)?

Paying above the secondary threshold incurs employers national insurance contributions (15.05%) and these are an additional business expense. However, if you are eligible for Employment Allowance (e.g. you have more than one employee/director on your payroll scheme) you will not pay employers national insurance up to the first £5,000 of liability per year. Note: When paying a salary up to the Primary Threshold this incurs approximately £420 of employers national insurance per year, therefore up to 11 directors could theoretically be paid this amount through one limited company each year before the Employment Allowance is fully utilised.

Will I still qualify for state pension and other National Insurance benefits?

Yes, as long as you earn (pay yourself) above the Lower Earnings Limit (LEL) of £123/week or £533/month, although you are not making National Insurance contributions, it will still count as if you are making contributions, so you will still receive the benefits associated with making them.‍

For further advice, or if you would like us to operate your payroll scheme, please get in touch.