If you’re running a limited company, paying yourself a lower salary and the balance in dividends from business profits, can offer a more tax-efficient alternative than simply paying yourself a salary. Despite the announced dividend allowance cut that will start from April this year, this strategy still has the potential to better maximise any post-tax earnings, as dividends aren’t subject to National Insurance Contributions.
You need to carefully consider the tax implications if you’re thinking of extracting cash from a company via a dividend, instead of paying yourself a salary or bonus – with this in mind we want to highlight the things you need to think about before making any decision.
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Paying A Salary
The company needs to register as an employer when anyone is paid more than the Lower Earnings Limit (currently £109 per week) – meaning any staff pay and payroll calculations will have to be reported to HM Revenue & Customs (HMRC).
Of course paying yourself a salary will be subject to income tax and National Insurance – so if you pay yourself a salary above the current personal tax allowance, which currently stands at £11,500 in 2017/18, then income tax rates will apply to any income above that amount.
The tax allowance will vary for some, so it’s important to calculate your tax profile accurately when working out your personal allowance. And remember, taxable income is the amount of earnings minus your personal allowance.
So if the new standard personal tax allowance of £11,850 is applicable to you, then below are the tax rates you pay in each band currently:
- Personal Allowance – Up to £11,850 – 0% tax rate.
- Basic rate – £11,851 to £46,350 – 20% tax rate.
- Higher rate – £46,351 to £150,000 – 40% tax rate.
- Additional rate – over £150,000 – 45% tax rate.
Also when it comes to National Insurance Contributions (NICs), if you’re paying yourself a salary above £155 a week – you’ll have to pay 12% of your gross earnings in NICs. Once it goes above £827 per week, the NICs will drop to 2%. Also, your limited company will have to pay an additional 13.8% of employer’s NICs on any earnings taken as salary that exceed £156 per week.
By keeping your salary portion low, you can either minimise NICs or even avoid these taxes entirely. This is why choosing to pay yourself a lower salary and the rest in dividends could be the most beneficial tax route for you.
Paying Through Dividends
If your limited company makes any post corporation tax profits, then you’ll be able to declare dividends, which can be paid to shareholders at any time as long as the company is currently in profit.
Profit for the limited company can be calculated by deducting any company expenses, like salaries, insurance and accountancy bills from any fee income – then deducting the current small business corporation tax rate of 20% from the profits. The balance that remains after this can be distributed as a dividend.
As of April 6th this year, the tax-free Dividend Allowance will be reduced to £2,000 – and dividend taxes use the same band thresholds for income taxes as seen above. So, you could earn up to £11,850 in personal allowance and £2k in dividend allowance without having to pay tax. Also keep in mind that dividends do not attract employer NICs. If you end up earning over £2k in dividends in the tax year, (from 6th April to 5th April the following year) the tax you pay will depend on which income tax band you fall into:
- Basic rate – 7.5%
- Higher rate – 32.5%
- Additional rate – 38.1%
The total tax cost may vary for you if your first £2k dividends ends up falling between two different bands.
Salary Versus Dividend
If you were to pay yourself a minimum salary and the balance in dividends, you will end up paying less combined tax and NICs than if you just paid yourself a salary, due to NICs being minimised. For example, if you fall into the basic tax rate and have already paid any corporation tax, the extra 7.5% tax will only apply to £30k of the £32k dividend earnings as per the new Dividend Allowance.
If you’re sharing ownership of your limited company with a spouse or civil partner, then you can make use of their tax allowance to further reduce any tax liabilities – by splitting the basic salary and the dividend income between yourselves. It’s clear that in regards to your limited company, going down the lower salary and dividends route can be beneficial for reducing tax liabilities and increasing net income.
Get Help With An Accountant
Remember, even though calculating dividends and taxes can be fairly complex, you shouldn’t have to do this yourself. An experienced professional accountant will be able to provide you with the right advice when you require it the most, and effective cloud based accounting software can make sure the task is made simple.
Choosing an accountant who specialises in providing services for limited companies and small business is essential, and of course ensure they have a thorough understanding of the correct balance when it comes to salary and dividends.
An accountant who can easily put your business accounts online using a popular cloud based system, like Xero, will be beneficial when it comes to solving your salary vs dividends problems.
So, if you’re still insure when it comes to paying yourself a salary or through dividends, then you can speak to us at RJF.
We specialise in a wide range of professional services, and we can be there to guide you through all the financial aspects of your business.
Make sure you contact RJF today, and get help making the best decision for your business.