Should I take a salary or dividends?

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    As a limited company director, you must make a crucial decision about how you remunerate yourself. Should you choose a salary, dividend payments, or both? Each option offers distinct advantages and can significantly impact your personal and company’s financial well-being.

    Salaries are subject to income tax and National Insurance, affecting take-home pay and pension contributions. Dividends, taxed at lower rates, offer a tax-efficient alternative for directors, enhancing personal wealth. Most choose to combine salary and dividends to optimise their tax position.

    Given the recent changes to both dividend and corporation tax rates, it’s wise to continuously reassess your remuneration strategy to maximise the tax benefits.

    Read on for Jameco Group’s helpful guide on choosing the right remuneration strategy for you and your company. For personalised advice, please feel free to get in touch.

    What should a company director consider before taking a salary or dividend?

    Before deciding on the right combination of salary, dividends or both, a company director should consider several critical factors:

    Income tax rates versus dividend tax rates

    You don’t pay income tax on your earnings until you surpass the personal allowance of £12,570. After that, basic rate taxpayers pay 20% on earnings up to £37,700.

    Dividend tax rates are considerably lower, and the basic rate is just 8.75% for the 2023/24 tax year. What’s more, there is a tax-free allowance on dividends on top of your income tax allowance.

    Therefore, despite the planned reduction in dividend allowance to £500 in 2024/25, dividend payments still offer a significant degree of tax relief.

    This makes taking dividends an attractive option for directors looking to optimise their personal tax situation.

    Corporation tax relief

    A salary payment is a tax-deductible expense that can reduce your company’s taxable income and, therefore, its corporation tax bill. However, it does incur National Insurance Contributions (NICs) for both the employer and the employee, adding to the overall cost.

    Importantly, salaries can be paid regardless of the company’s profitability, providing a consistent employment income even in the absence of business profits.

    National Insurance Contributions (NICs)

    When deciding between salary and dividend payments, NICs (National Insurance Contributions) come into play. Choosing a salary means that both the employer and the employee are obligated to pay NICs, which could impact the company’s net income and financial obligations.

    However, it’s worth noting that the Employment Allowance is available, which can offset some of the employer’s NICs liability under certain conditions, thus mitigating the financial impact. On the other hand, dividends do not attract NICs, making it a more tax-efficient way of extracting profits from the company.

    Company cash flow

    Your decision should also be influenced by when your company needs to pay tax, which affects cash flow. Dividend payments depend on the available post-tax profit, whereas salaries are a fixed and planned expense regardless of profit levels.

    Tax and National Insurance are deducted at source for a salary payment, whereas dividend income wouldn’t be taxed until your self-assessment was due.

    Salary vs dividends

    The majority of limited company directors take a combination of salary and dividend payments, frequently supplemented by business pension contributions.

    The ideal salary-dividend ratio varies from case to case and hinges on several factors:

    • Company Profits: Dividends are distributed from post-tax profits, so your company must be generating a profit to even consider this option.
    • Tax Savings Goals: Is your tax strategy to minimise your income tax bill, corporation tax liability, or both? If one is more of a priority, this will naturally affect the ratio of salary vs dividends.
    • Other Income: In addition to salary and dividends, other income streams, such as investment income, can significantly impact your overall tax situation. This will determine which tax bracket you fall into and how you use your various tax allowances, which will influence your decision on salary vs dividends.

    Benefits of taking a salary

    There are benefits and drawbacks of taking a salary for both you personally, and your company.

    • Guaranteed Income: Salaries are paid regardless of company profits, providing you with a stable employment income.
    • State Pension Qualification: Regular salary payments contribute to your National Insurance record, which is essential for qualifying for the state pension.
    • Pension Contributions: Salaries enable higher pension contributions, enhancing your retirement savings.
    • Tax Efficiency: Salaries are an allowable business expense, potentially reducing your company’s profits and corporation tax liability.
    • Financial Credibility: A consistent salary can simplify financial dealings, such as applying for mortgages or loans, due to its predictable nature.
    • Maintained Benefits: Adhering to National Minimum Wage standards secures entitlements such as maternity benefits.

    Drawbacks of taking a salary

    • National Insurance Costs: Both you, as a company director, and the company itself must pay National Insurance, increasing the overall tax burden.
    • Higher Income Tax Burden: Salaries are subject to higher income tax rates compared to dividends.

    Benefits of taking dividends

    • Reduced Income Tax: Paying dividends can significantly decrease a director’s overall tax liability, as dividend tax rates are far more favourable than income tax.
    • No NICs: Dividends are exempt from National Insurance, further enhancing tax efficiency.
    • Dividend Allowance: Company directors benefit from the tax-free dividend allowance on top of their personal allowance.

    Drawbacks of taking dividends

    • Profit Dependency: Dividends are contingent on company profits, limiting income during unprofitable periods.
    • No Corporation Tax Relief: Unlike salary, dividends are not tax-deductible, so they do not reduce the company’s corporation tax bill.
    • Director’s Loan Risk: If you pay dividends and the company doesn’t have the available profits, it will be treated as a director’s loan and potentially subject to section 455 tax up to 33.75% on the outstanding amount.

    What is the most tax-efficient way to pay yourself as a company director?

    Determining the most tax-efficient way to pay yourself as a company director, whether with a salary, dividends, or a combination of both, depends on your income level, individual tax circumstances and goals.

    Most business shareholders find that drawing an optimal salary up to the tax-free allowance, complemented by dividend income, is the most tax-efficient strategy. It’s important to note that both salary and dividends contribute to personal income, which has an income tax implication.

    The decision isn’t merely about choosing salary vs dividends but leveraging strategic tax planning. Owning a limited company offers the flexibility to optimise how and when you extract funds, aligning with tax-efficient practices.

    This approach not only aids in maintaining a lower corporation tax bill but also ensures personal tax efficiency, making it a key strategy for directors seeking to enhance their company’s financial health and personal wealth.

    Optimise your income with Jameco Group

    Deciding how to pay yourself as a business owner isn’t straightforward. The choice between a salary and dividends rests on various factors, considering both your personal needs and those of your business. It’s all about the details, which is why, at Jameco Group, we delve deep to understand your unique situation.

    Our team can help you identify the optimum ratio of salary vs dividends to minimise your tax burden, depending on your income level and goals.

    Are you keen to discover the most tax-efficient way of extracting profits from your business? Get in touch with our tax experts today.

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