Salary V Dividend
The purpose of this article is to help new business owners understand the difference between taking a salary and dividends and how to balance payments. I have skipped the numbers and jumped straight to the answer in order to make the article as light as possible.
Dividends are paid from a company’s retained earnings. That is to say, it is paid from the company’s overall profit since incorporation. If the company does not have retained earnings, it is illegal to pay a dividend.
Dividends are paid to shareholders based on their percentage of shares owned in the company. If you do not hold any shares, you cannot be paid a dividend.
A dividend is not an expense for the company. It does not reduce the amount of tax the company will pay. It is effectively paid from ‘profits after tax’.
You do not pay national insurance on dividend payments.
The company must issue dividend minutes when it declares a dividend, but there is no responsibility to file anything with HMRC.
A salary is a company expense. It can be paid whether or not the company has been profitable.
From the perspective of the company it is a valid expense to reduce the net profit of the company. Therefore, it will reduce the end of year tax payable.
It goes without saying that a salary can be paid to any employee of the company, you do not need to hold shares.
To pay a salary the company needs to be registered with HMRC as an employer and must file monthly PAYE returns.
Both the individual and the company pay national insurance on a salary above a certain limit.
Now we have differentiated between dividends and salary we need to consider which is the best way to withdraw money from your company, whilst keeping tax to the minimum.
The best way to do this depends largely on the circumstances of the individual. For the tax year 2019/20, in most circumstances the following is used:
A salary of £8,632 per year is taken and any further drawings are taken via dividend payments. This way no NI is paid by either the company or the individual.
The £8,632, will usually be split monthly or quarterly.
It may not be the individual’s preference to withdraw money in the most tax efficient manner. In which case the above would need to be reviewed.
The above assumes the individual’s only income if from their company. If the individual has any other income the above will need to be adjusted.
If taking more than a total of £50,000 in salary and dividends for the year 2019/20, then the individual will be pushed into the higher rate band and will start to pay tax at higher rates. Additional tax planning may be required.
The £8,632 per year is above the Lower Earnings Limit for National Insurance required in order to qualify for state benefits (for 2019/20, this is £118 per week).
The above assumes you cannot claim the employment allowance of £2,000 per year as the director is the only employee of the business.
Remember the above is only a rough guide to give a basic understanding of dividends and salary. Your personal situation and circumstances will affect the best action advisable. If you have any questions on the above or require any guidance please contact us at your convenience
The information contained within this document is correct at the time of issue. Advice should be sought from an accounting or tax professional before following any guidance.