Salary planning: balancing personal and company tax efficiency. 

As a director in an owner-managed business, your choice of salary structure can have important tax and financial implications. While taking a lower salary and drawing dividends may seem tax-efficient from a personal standpoint, there are broader considerations - particularly for companies claiming R&D tax relief. 

Here are key points to consider when setting your salary: 

State pension credit eligibility – To build qualifying years for your State Pension (assuming no other earned income), your salary must exceed the Lower Earnings Limit of £6,500 annually (2025/26 rate). 

Tax-free childcare eligibility – To qualify for tax-free childcare, you must earn at least 16 hours at the National Minimum Wage or National Living Wage. For 2024/25, this means a salary of at least £9,518 for those aged 21 and over, rising to £10,158 in 2025/26. 

Impact of higher earnings on childcare support – If your Adjusted Net Earnings exceed £100,000, you will lose eligibility for tax-free childcare. 

R&D Tax Relief and maximising business benefits – If your company carries out qualifying R&D activities, your salary (plus NICs and pension contributions) counts as eligible R&D expenditure. By taking a commercial salary, rather than a minimum salary and dividends, you could significantly increase your company’s R&D tax relief claim. This approach may enable your company to recover up to 27% of the additional salary cost as tax relief. 

While dividends often provide personal tax savings, a balanced approach, ensuring your salary reflects your commercial role in the business, can enhance your company’s tax efficiency and R&D relief opportunities.

Pre 5 April 2025 Tax Planning

Personal allowance - protect your £12,570 tax-free income. 

For 2024/25, your personal allowance is £12,570 – the amount of income you can earn before paying income tax. However, this allowance is reduced by £1 for every £2 of net relevant earnings you have over £100,000, and therefore is fully lost once your income exceeds £125,140 (the effective tax rate in this band of income is 60%). 

Furthermore, families that utilise the Tax Free Childcare scheme, and 15 or 30 free hours, may lose entitlement to this support where one of the parents earns over £100,000, and so ensuring that your income remains below this threshold is valuable. 

Expert Tip: 

If your income has exceeded £100,000, you can reduce your net relevant earnings by making personal pension contributions, or through charitable donations. Both of these strategies can help restore your personal allowance, and reduce your net relevant earnings below £100,000, and your overall tax liability.

Pre 5 April 2025 Tax Planning

Dividends. 

In addition to personal allowance, your first £500 of dividend income is taxed at 0%, after which the following tax rates apply: 

8.75% for basic rate taxpayers. 

33.75% for higher rate. 

39.35% for additional rate. 

It is important to plan ahead, with a view to managing dividend income across tax years. Any unused allowances/tax bands cannot be carried forward into the following tax year – if you don’t use it, you lose it! 

Professional advice can make all the difference! 

Be cautious when setting your salary below the personal allowance threshold of £12,570 to avoid losing eligibility for state pension credit and tax-free childcare. Similarly, be mindful of the implications of earning over £100,000, as this can affect your entitlement to tax-free childcare, reduce your personal allowance, and impact your tax rates. 

Expert Tip: 

Take dividends to use up your 0% allowance, and any available basic rate tax band (up to £37,700). 

Where your spouse/civil partner has unused allowances/tax bands, consider gifting them shares (gifts of assets between spouses/civil partners are free from capital gains tax) to utilise the allowances and maximise tax effective income for the household.

Child Benefit – watch out for the high-income charge. 

If you or your partner have adjusted net income over £60,000, you may be subject to the high income child benefit charge (HICBC). This applies as follows: 

Income between £60,000 and £80,000: you repay 1% of child benefit for every £200 over £60,000. 

Income of £80,000 or more: the full child benefit amount must be repaid. Expert Tip: 

Making personal pension contributions will reduce adjusted net income, reducing the HICBC and therefore preserving child benefit. Furthermore, gift aid donations will also reduce your adjusted net income. You will need to ensure that these contributions are made on or before 5 April 2025 to reduce your income for this tax year. 

Pensions - the ultimate tax planning tool. 

Pensions remain one of the most effective ways to reduce your tax bill, whilst building long-term wealth and supporting estate planning. They can help mitigate higher taxes, manage tax bands, and reclaim lost allowances, including child benefit, childcare funding support and personal allowances. 

The annual allowance for pensions is £60,000 (subject to tapering). You can carry forward unused annual allowances from the previous three tax years, as long as you were a member of a UK pension scheme during those years. For example, if you had £10,000 unused annual allowance in the prior 3 tax years, you may be able to contribute up to £90,000 this tax year (subject to your earnings) giving you significant tax-saving potential (e.g. £60k current year, plus 3 x £10k for prior years). 

Contributions must be received by your pension provider before 5 April 2025 to count for this tax year. 

Contributions attract tax relief at your highest tax rate (20%, 40% or 45%). Meaning a £1,000 pension contribution would cost £800 for a basic rate taxpayer. For higher earners, it can cost as little as £550 after claiming extra relief.

Why act before 5 April 2025?

It makes financial sense to be proactive. 

Proactive tax planning, ahead of the new tax year, can ensure you use up all available allowances, optimise your income and profit extraction, and avoid unexpected tax bills. 

Unused dividend allowance and tax bands should be utilised where possible by 5 April 2025. 

Unused pension allowances from 2021/22 will expire if not used before 5 April 2025 (tax relief is only secured once the contribution is received by your pension provider). 

Pension and charitable contributions are effective tools to reduce your tax bill, reinstate child benefit and childcare support, and boost your retirement savings at the same time. You can preserve your personal allowance by making pension contributions and charitable donations to bring your income below £100,000. 

How can Onside Tax help? 

At Onside Tax, we help startups navigate complex tax regulations, minimising liabilities while ensuring compliance and fostering business growth. 

In addition, we assist individuals with their personal tax affairs, offering tailored advice on self-assessment, tax planning, and reliefs to optimise their financial position and ensure full compliance. 

If you need support reviewing your personal strategy, now is the time to act! 

www.onsidetax.com 

ryan.snape@onsidetax.com