Minimum Income Trap - What SME Directors Need to Know
Welcome to the next article in our Accounting & Tax 101 series — short, plain-English guides to help you understand the numbers that matter.
If you’re a company director who takes a mix of salary and dividends, you’re probably used to thinking about tax efficiency first. But if your family is hoping to use the new free childcare hours, there’s another important point to watch — whether your earned income is high enough to qualify. This is a new area of childcare support, and it’s something that could easily catch many directors out without them realising.
What counts — and what doesn’t — as “income” for free childcare
For childcare eligibility, the government only looks at the income you earn from actually working. Anything classed as “passive income” won’t help you meet the minimum requirement.
Here’s how it works for director-owners:
Income that DOES count (earned income):
Your salary
Any self-employed earnings (if you also trade personally)
Income that DOES NOT count (passive income):
Dividends
Director’s loan withdrawals
Interest
Rental income or other property income
Pension income
So even if you take large dividends, they won’t help you meet the childcare earnings test — only genuine paid work does.
The minimum amount you need to earn
To qualify, you must earn at least the equivalent of 16 hours a week at the National Minimum Wage. For most directors aged 21 or over, this works out to a little over £2,500 in earned income over a three-month period.
This is where directors can get caught out:
Taking a very low salary
Relying mainly on dividends
Withdrawing funds through the director’s loan account
Even though this setup can, in many circumstances, work well for tax, it doesn’t meet the childcare rules — and you could miss out on support worth thousands of pounds a year.
Why SME directors are particularly at risk
Many owner-managers follow the familiar “low salary, higher dividends” setup. It isn’t the most tax-efficient approach in every situation, but for many directors it still offers a good balance between tax planning and cash flow. Many owner-managed businesses have used this approach for years without any issues, which is exactly why the new childcare rules could take people by surprise.
The challenge is that the childcare system looks at income very differently from the tax system. It focuses purely on what you earn from work over the next three months, and ignores all passive income — including dividends.
This means that a salary set just a bit too low can suddenly leave you below the required earnings level, even if the business itself is doing perfectly well.
What you can do now
A little planning goes a long way:
Check your salary and make sure it clears the minimum requirement
If needed, increase your salary slightly so you don’t fall short
Plan ahead, so you’re not making changes at the last minute
If your income varies, consider paying yourself a steady monthly salary to keep things predictable
Often, adding just a few hundred pounds to your salary can secure your eligibility.
If you'd like support reviewing your income levels or setting up a director’s remuneration plan that works for both tax and childcare eligibility, we’re always happy to help.
This article is part of our Accounting & Tax 101 series — short guides to help you understand your accounts without the jargon.
