actd wrote: @DavidChannon, just want to clarify, the first £5000 of dividends are tax free, but presumably taxable income, in the same way that if you earn less than £11k, it's tax free (because of personal allowance) but is still taxable, ie it still counts towards the tax calculation, even if no tax is actually due. Is that correct, and if so, even if he takes only £5k in dividend and minimum wage (which he is still legally obliged to pay himself), it's going to count towards the CMS calculation - or have I got that wrong?
CMS use the "final figure" from HMRC which is all income post pension and pre tax. So yes that includes the first £5k dividends and any wages - plus any other income.
e.g. you can earn £60k a year and pay some higher rate tax - but that first 5k of dividend income is tax free.
Lots of people make incorrect assumptions that Dividends are not taxed at all ( it sort of used to be true to a certain level ).
Another incorrect assumption is that he is legally obliged to pay himself minimum wage. That is just not true.
A director(s) of a company can pay themselves whatever they want - they are not considered a "worker" for huge parts of employment law. Directors of limited companies will often pay themselves approx £8k or approx £11k a year - that comes from being tax efficient. Whilst you pay income tax on dividends - you don't pay national insurance. £8k and £11k are the limits for paying national insurance ( which one depends on the exact setup of the company and other tax rebates the company can get related to national insurance ). It is not however anything to do with minimum wage. If you are 25 and over minimum wage actually works out at about £14.5k for a 37.5 hour week.
So if someone has a limited company they can choose:
1) Take no wages - no dividend - CMS sees £0
2) Take no wages - £5k dividend - they pay no tax - CMS sees £5k
3) Take 8k wages - £5k dividend - they pay no tax, no NI - CMS sees £12k
4) Take 11k wages - £5k dividend - they pay no tax, small NI - CMS sees £16k
5) Take 11k wages - £34k dividend - they pay tax, NI - CMS sees £45k
It all does get more complicated however when you look at how limited companies are setup. Lots of limited companies (especially for contractors ) will be setup with husband and wife as directors, shareholders and getting wages.
In those situations it does get more complicated because:
- Husband remarries - sets 50/50 ltd company with new wife
- Both take £11k salary - both take £5k dividend
- The household would bring in £11k+£11k+£5k+£5k = £32k - minimum tax through maximising personal tax allowances
- BUT CMS would only see £11k+£5k because only the Husband's income counts when calculating CMS for children from his previous relationships.
One huge problem with this area is that these setups of limited companies are VERY common - its not only done by people trying to reduce/avoid paying the CMS - its done by thousands and thousands of people in how they work and how accountants tell them to setup to be tax efficient. This is why the CMS and HMRC have such a hard time dealing with it and changing it for the CMS cases - they can't "attack" all limited companies for the small % that are done for CMS avoidance purposes - and they can't restrict individuals who owe under the CMS from having limited companies when anyone else can.
actd wrote: I had that a long time ago when I was contracting, I thought IR35 (around 2000/01) curtailed that, but maybe not. Thanks for that :-)
IR35 relates to working as an employee but getting taxed as a ltd company. Some contractors end up working as employees because they are given laptops, work set hours, get holiday, have line manager, reviews and so on.
It does not stop/prevent any ltd company setup - its just as long as the work done by the principal contractor is not IR35 - and even then you can have a ltd company and do both IR35 work and standard contractor/freelance work. The tax is just calculated slightly differently. Many online systems do this all automatically now so its easy.