Should I pay myself and my family a salary from my property company?First Published: May 2021 | Available in: Property Articles Your Property Network
Many property investors operate a property company, and have the option of paying a salary to themselves, or even their family who may help with managing the business.
This article looks at when it is beneficial to pay a salary, and if so, how much, and what is involved from an admin view.
I’m a company director & shareholder … is paying a salary worthwhile?
As the director and shareholder of a property company, or a trading company for that matter, you can decide whether to pay yourself a salary, and if so how much.
The main purpose of paying a salary is:
- To use the annual Personal Allowance (2022: £12,570), and
- To ensure entitlement to the State Pension & certain statutory benefits
As with many aspects of the UK tax system, the annual Personal Allowance (which allows some income to be earned without personal tax charged) operates on a ‘use it or lose it’ basis, and so it is important that the Personal Allowance is used each year if at all possible.
Unlike dividends, company salaries are paid pre-tax by a company, and so a company gets tax relief for the salary cost, while in most cases the salary is tax-free for the employee / director.
e.g. a £12,500 salary paid to a director with no other income would not be taxable, whereas at the 19% corporation tax rate, the company’s corporation tax bill would be reduced by £2,375.
OK, so what are the options in terms of salaries?
The following 3 options are most commonly operated (however tax-planning advice should be taken about individual circumstances) – figures are for the 2022 tax year:
1. Salary of £1,045 per month i.e. £12,540 per year
- No income tax as makes use of full 2022 Personal Allowance
- Employee NI due of £357
- No Employer’s NI due for the year due to Employers Allowance (if relevant)
- Corporation tax saved @19% = £2,383
2. Salary of £800 per month i.e. £9,600 per year
- No income tax (£2,970 of 2022 Personal Allowance unused however this can be used against other income e.g. rental income)
- Employee NI due of £4
- Employer’s NI due of £105
- Corporation tax saved @19% = £1,824
3. Salary of £520 per month i.e. £6,240 per year
- No income tax (£6,330 of 2022 Personal Allowance unused however this can be used against other income e.g. rental income)
- No Employee or Employer NI to pay
- Corporation tax saved @19% = £1,186
As a general guide:
- directors & employees who have no personal income should pay themselves an ‘Option 1’ salary
- directors & employees who do have personal income but are not Higher Rate (40%) taxpayers should pay themselves an ‘Option 2’ salary
Both the above options will ensure the Personal Allowance is used in full and ensure entitlement to the State Pension & certain statutory benefits.
- directors & employees who do have personal income, are not Higher Rate (40%) taxpayers and don’t require State Pension & certain statutory benefits entitlement, could pay themselves an ‘Option 3’ salary (but unlikely to be beneficial unless the Personal Allowance would otherwise not be used)
Managing a PAYE scheme
Of the above 3 options, Options 1 & 2 require that a formal ‘PAYE’ scheme (Pay As You Go) to be registered for the company. This involves an initial registration and monthly online submissions plus a final ‘month 12’ submission with employer P32 & employee P60 notices, and possibly P45 / P11D notices for leavers and if Benefits-In-Kind (e.g. tax-efficient electric company cars, since April 2020!) are relevant.
Most accountants will charge an extra fee for the operation of a PAYE scheme, with associated tax advice to ensure that the most tax-efficient PAYE salaries are paid to each individual.
What about directors? Are they treated the same as employees?
As a director of a company, there is no requirement to be paid via the National Minimum Wage regime, unless you have a ‘Contract of Employment’ with the company (which directors of ‘personal’ companies have no need for). And, directors have more flexibility than non-director employees in that the National Insurance regime does not work on a ‘cumulative’ basis for directors, allowing potentially nil or low salaries to be paid during a tax year and a large ‘month #12’ salary to be paid in March each year, allowing extra flexibility if required.
Salaries – interaction with dividends
Dividends can also be paid from a company, separately to any salary, to supplement a director’s salary.
For an ‘Option 1’ salary (with no other personal income) as a shareholder you can draw approximately £37,730 of dividends per tax year without incurring any ‘Higher Rate’ personal tax. Above this limit Higher Rate tax becomes payable under Self-Assessment at 32.5% on the ‘excess’ dividends.
So, this allows a combined £12,540 salary + £37,730 = £50,270 of personal income to be taken from the company, for a total personal tax bill of just £2,675 (after the £2,000 tax-free dividend allowance). This means a monthly personal income of £3,967 and a personal tax rate of just 5.3%. For a typical 2-director company this means over £100,000 of company profits can be withdrawn for a total personal tax bill of just £5,350.
For an ‘Option 2’ salary scenario, the tax-efficient dividends figure to withdraw becomes £40,670 of dividends per tax year without incurring any ‘Higher Rate’ personal tax.
Salaries – interaction with rental profits
Many property investors have personally-owned rental properties, as well as a company (whether a property company or not) that could pay a salary and dividends to each director/shareholder.
Generally, so long as the director’s total income is less than the Higher Rate tax threshold (2022: £50,270), it is tax-efficient to pay an Option 1 or 2 salary, as the total salary & rental income dividend income would still be taxed at the Basic Rate of tax (20%), and the company gets a tax deduction at 19% for the salary cost.
Salaries – Higher Rate taxpayers
For directors with personal income that is already above the Higher Rate tax threshold (£50,270), paying a salary would actually result in a tax increase, as the salary is taxed at 40% on the individual, whereas the company only receives tax relief at 19% … we have seen plenty of new clients not realise that their salary is increasing their overall a tax bill by £2.5k per year!
Instead, entitlement to the State Pension & certain statutory benefits can be achieved by paying voluntary Class 3 National Insurance payments. Currently, it is also possible to pay Class 2 NI payments, although HMRC have confirmed that this option will be stopped in the next 1-2 tax years. Class 3 NI costs around £750 per tax year, whereas Class 2 NI costs around £150 per tax year.
What about the ‘Option 3’ salary?
For salary payments of below £6,240 per tax year, per person, there is no need to operate a formal PAYE scheme (this threshold is known as the Lower Earnings Level, or ‘LEL’).
Many property companies may pay amounts up to this level to family members for casual property management support, refurb & project management etc, which is a tax-deductible expense for the company, and may not be taxable for the individual if the Personal Allowance hasn’t been fully-used.
It is still important to keep proper records of hours worked, wage rate paid, total paid etc, and take care to pay commercially-justifiable rates though – remember, by including such wages in a company’s accounts (and therefore tax return), you make these payments business expenses which may be scrutinised by HMRC. Such wages must be for actual work done – it would be tax fraud to include fictitious payments in business accounts. In particular, it is important that payments are actually made, ideally to the bank account of the individual rather than cash.
Paying a salary from a company to a director / shareholder can be a tax-efficient way to extract money from a company, and ensure entitlement to the State Pension & certain statutory benefits.
By carefully assessing the personal income position of each individual, the most tax-efficient salary can be calculated and paid by the company, ensuring that each person’s Personal Allowance is used, with a corresponding tax deduction for the company.
As with many aspects of the tax system, the Personal Allowance can’t be ‘accumulated’ if it is unused, and so it is important to ensure the Personal Allowance is used in the most efficient way each year. As salaries are deductible for a company before corporation tax, this presents the useful option of being able to take a personal-tax-free salary but receive a tax deduction via the company for the salary – sometimes known as a ‘one-sided’ tax benefit. A common mistake, for example, is to have the Personal Allowance used with dividend income, which would save no corporation tax at all.
This is where a carefully considered company profit extraction approach, with a cumulative impact over multiple tax years, can make a real difference …