It is common for business owners to pay themselves via a combination of salary and dividends. Business owners will look to take cash out of their business in the most tax-efficient way. In many instances, that will be by way of a small salary and dividends. Both will have an impact on the tax a company pays and on the personal tax the director will pay.
The benefits of taking a salary will include qualifying contributions towards a state pension, the ability to make higher pension contributions, and reducing the corporation tax the company pays. Company directors can take a salary even when a business makes a loss and often find it easier to secure a mortgage when looking to buy a home.
However, the downside to a higher salary will mean increased personal and company national insurance contributions and higher rates of income tax.
Dividends can only be paid to directors and shareholders from the profits a company makes and come with two significant benefits: they attract a lower rate of income tax and there is no requirement to pay national insurance contributions.
There are, however, drawbacks to taking dividends over a salary. They will not reduce a company’s corporate tax liability and do not count as relevant earnings for pension contributions. If a dividend is paid and there are insufficient profits to cover that payment it will be considered a director’s loan and that will need to be repaid.
Directors who take dividends will often find it more challenging to secure a mortgage on a home with lenders unable to consider it as income.
The tax-free dividend allowance is also changing in 2023, dropping from £2,000 in the 2022/23 tax year to £1,000 in the tax year 2023/24 and to just £500 in the tax year 2023/24. This will change the amount of tax company directors will pay on dividends.
Combining salary and dividends will remain in many instances a valid way for business owners to take cash out of a business, but a holistic view is needed.
Every individual has different circumstances and as always, advice should be taken before taking or refraining from action. Speak to your advisor or get in touch.
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