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What is the most tax-efficient way to pay yourself in 2020/21?

How can contractors pay themselves tax-efficiently in the 2020/21 tax year?

Q. Like many contractors, I don’t have much time on my hands to make sure I’m operating in the most tax-efficient manner, while my contractor accountant isn’t particularly proactive in their approach. With this in mind, I wanted to ask what the most tax-efficient way of paying myself through my limited company is for the 2020/2021 tax year, via salary and dividends. Any guidance would be much appreciated. 

A. Before being able to answer this question, it’s important to note that there is not a one-size-fits-all solution to tax planning. As contractor accountants, we must consider factors such as prior employment, other existing employment or self-employment arrangements, other sources of income and also your personal circumstances and requirements. It’s therefore crucial that you chat with a contractor accountant, who will be well placed to provide a tax strategy tailored to your specific needs.  

However, many contractors tend to pay themselves a low salary which is then topped up with company dividends. As based on the current HMRC rules, this is more tax-efficient when compared to paying yourself only a salary. While this is only guidance, and per above we cannot assume that this strategy applies to your personal circumstances, for the 2020/21 tax year, the basic salary we recommended depends on whether you are operating as a sole director/employee or if you employ other staff (such as your spouse) in the company.

Sole employee – where you are the sole director, shareholder and employee of the company, the most tax-efficient salary is normally the National Insurance limit of £9,500 per annum. Although, we normally recommend setting the salary a nominal amount higher than this (for instance at £9,540) to safeguard qualification for the state pension.  

Salary  Dividend  Tax rate Money withdrawn
£9,540 £4,960 0.0% Up to £14,500 (Personal allowance £12.500, plus dividend allowance £2,000)
£9,540 £4,961 to £40,460 7.5% £14,501 to £50,000
£9,540 £40,461 to £140,460 32.5% £50,000 to £150,000
£9,540 £140,461 + 38.1% £150,001 +

More employees – where you employ other staff in addition to yourself, the most tax-efficient salary is normally the Personal Allowance value of £12,500. A higher value can be paid as a salary because the company is also eligible for the Employment Allowance.

Salary  Dividend  Tax rate Money withdrawn
£12,500 £2,000 0.0% Up to £14,500 (Personal allowance £12,500, plus dividend allowance £2,000)
£12,500 £2,001 to £37,500 7.5% £14,501 to £50,000
£12,500 £37,501 to £137,500 32.5% £50,000 to £150,000
£12,500 £137,500 + 38.1% £150,001 +

The figures in the above table apply to each employee/shareholder (assuming equal ownership percentages of the company). This answer was provided by a contractor accountant at QAccounting. You can ask the Contractor Doctor your tax, IR35 and contracting questions here.

By Contractor Doctor

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4 thoughts on “What is the most tax-efficient way to pay yourself in 2020/21?”

  1. Andrew Harrison

    Attitudes and articles like this are exactly the red rag that leads to legislation like IR35.
    Personally, I recomend pension contributions to reduce the tax bill. If you really want to cut the tax man’s share then give to charity.

  2. ganymede

    You would have thought after furlough scheme excluded dividends many would have learnt the lesson. I aim to use a negative effective tax rate. Pay full PAYE then, reduce the tax to zero with things like EIS/SEIS, VCT’s to give me tax relief. Then a personal pension contribution give additional tax relief over and above that used to give a zero tax bill. Then use pension as a means to reduce inheritance tax rather than a pension, along with the EIS/SEIS shares. If share fail then you have the loss relief that can be used.

    This is my fun way of dealing with the Loan Charge, dangle the Loan Charge tax in front of HMRC, only to whip it away at the last moment with all the tax relief, and grab an even large amount of tax relief than the taxes from the Loan Charge. This can be done to more less every single “Tax Avoidance” measure, IR35 is about allowing those with deep pockets to pay less tax while ensuring those less well off pay all the taxes – “Tax Avoidance” is all about hammering those less well off for all the taxes possible and ensuring unlike those with deep pockets there is no avoidance of paying more than their share.

    PAYE tax payers aren’t the saints HMRC would have everyone believe they are, the Loan Schemes, Dividends aren’t the solution, you can only get 0%, PAYE the negative effective tax rate can be as much as -140%. Use of Loan Scheme was actually a kindness, thankfully the Loan Charge for a few like me allow that kindness to be reversed and reduce overall taxes far beyond that of the Loan Scheme.

    This only works if you have deep pockets, and that’s the confusion, it’s never about tax avoidance, for most it about boosting take home pay, a necessity for those that don’t have deep pockets.

    I’ve enough in pensions much of that had 40% tax relief, and the expectation of HMRC, Treasury is to pay 40% tax when taking the pension, I built up ISA along side, which means I can take pension at mostly 0%, and give way the rest as pensions are outside estate avoiding the inheritance tax.

    Use of share dividends isn’t a free ride, as furlough showed, it’s giving away the rights to tax relief and benefits, which can be much more valuable. The Government is shirking it’s responsibility having implemented a dividend tax to make up for lost National Insurance, and should be giving the benefits attributed to National Insurance, rather than grabbing extra as taxes for free.

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