Optimum tax efficiency for owner-managed companies

There are several changes coming in for the new tax year. How will they affect owner-managed companies, and how can they use the changes to achieve optimum tax efficiency?

What’s changing?

  • The dividend allowance will fall by 60% to just £2,000 per individual.
  • The personal tax allowance will increasetp £11,850.
  • The basic rate band will be £34,500 – you will need to earn in excess of £46,350 before paying tax at the higher rate.
  • Scottish taxpayers will be subject to different rules because of the new five-tiered income tax system for 2018/19. For example, the higher rate will start at £43,430 and will be 41% instead of 40%.
  • The abolition of Class 2 NI has been delayed until 2019/20 at the earliest.

 What does it mean for you?

  • The primary and secondary thresholds for Class 1 NI will both increase to £162 per week (£8,424 per year). If you are a director or employee, a salary paid below that level will not incur any Class 1 NI liability, but you will still get a full state pension contribution year.
  • Sole traders with profits of £25,000 in 2018/19 will only save approximately £700 in tax and NI by incorporating. With profits between £50,000 and £145,000 the tax savings are more significant, making incorporation worthwhile. However, where the profits exceed £145,000 it is actually more tax efficient to remain a sole trader.
  • For 2018/19, one-man companies will see the greatest tax efficiency by restricting the director’s salary to £8,424, and taking further required cash as dividends.

What if I have already incorporated?

If you have already incorporated, the focus shifts to the optimal balance of salary and dividends. For 2016/17 and 2017/18, a single director company with no other employees was better served by taking a salary equal to the primary threshold, and not the personal allowance. However, the reduction in the dividend allowance means that for a one-man company, the salary equal to the secondary NI threshold of £8,424 will be the most efficient option for 2018/19.

If the employment allowance is available, i.e. where you have other employees, a salary equal to the personal allowance is the best option, but only by £28. It will certainly not be worth bringing in temporary employees just to secure that saving. However, if you can utilise a spouse, you could achieve greater savings, with the employment allowance as the cherry on the top.