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Salary vs dividends for Limited Company Directors

If you are a Director of a limited company, there are several options available to you to withdraw funds from your company. The best route for you will entirely depend upon your income and circumstances and not everyone will be the same. However, the most popular options are to draw money out of their company in salary, dividends or a mixture of the two. This article will explain the options available.

Taking a salary from your limited company

The benefits of taking a salary from your limited company

  • You can take a salary even if your business makes no profit

  • You build up qualifying years towards your state pension

  • You can make higher personal pension contributions

  • Salaries are allowable expenses so they reduce the amount of Corporation Tax that your limited company will have to pay.

  • It can be easier to apply for a mortgage, loan or insurance policy if you are on a payroll PAYE scheme.

  • You can retain benefits such as SSP or Maternity pay if your limited company employs you and is compliant with National Minimum Wage regulations

The drawbacks of taking a salary from your limited company

  • Salaries incur higher rates of income tax than dividends

  • When you take a salary from your limited company, both you and the company may be required to pay NICs

Taking dividends as income

A dividend is a share of the company’s profits after all liabilities including Corporation Tax have been settled. Dividends are paid to all shareholders and directors and the amount paid depends on the proportion of the shares they hold. There is no requirement for a Limited Company to pay out annual dividends. Unlike PAYE salary, dividends are not liable for NICs or Income Tax deductions at the time of payment although they do need to be declared via a Self Assessment.

The benefits of taking dividends from your limited company

  • You can significantly reduce your Income Tax bill by taking some of your income as dividends

  • No employers or employees NICs are payable on dividends

  • You have a tax-free dividend allowance which is in addition to your personal allowance

The drawbacks of taking dividends from your limited company

  • Dividends can only be paid out of profits which means if your company does not make a profit, then you cannot pay dividends

  • Dividend payouts are taken from profits after Corporation Tax unlike salary payments

  • If you take a dividend payment that is not subsequently covered by the company’s profits, you will essentially have taken out a director’s loan, which you must repay

How are salary and dividends taxed?

Salary and dividends work in very different ways. Salary is liable for NICs and Income Tax, which will be deducted from your earnings depending on how much you choose to pay yourself. The Income Tax thresholds for salary for the 2021/22 tax year are as follows:

Tax Band Taxable Income

Personal Allowance £12,570 per year

Basic Rate 20% on earnings above the PA and up to £37,700

Higher Rate 40% on earnings between £37,701 and £150,000

Additional Rate 45% on earnings above £150,000

Dividends are taxed differently as they are not liable for Income Tax or NICs. The dividend tax allowances and thresholds for the 2021/22 tax year are as follows:

Tax Band Tax Allowance

Dividend Allowance £2,000

Basic Rate 7.5% on taxable income over the PA up to £37,700

Higher Rate 32.5% on taxable income between £37,701 and £150,000

Additional Rate 38.1% on taxable income above £150,000

For 2022/23, the Personal Allowance remains the same at £12570 but Dividend taxation will change with each band increasing by 1.25% to 8.75%, 33.75% and 39.35% respectively

Should I pay myself a salary, dividends or both?

Ultimately, deciding whether to pay yourself dividends or a salary or both will depend on your personal circumstances, the tax bracket you fall into, and your desired level of income. Most limited company directors find that the most tax-efficient way to operate is to pay themselves a salary up to the tax-free allowance and receive the rest of their income via dividends.

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