FREQUENTLY ASKED BUSINESS QUESTION
Deciding between Salary vs Dividend when taking income from your company: I run a small company with my son and we are 50:50 owners. We have always taken salaries and bonuses as our reward from the business, as our company did not have reserves to pay us dividends. Now that the company has returned to profitability, can you explain what is the most tax-efficient way for us to take income from the company?
What Are Dividends?
Dividends are the company profits that are given out to shareholders. When a company makes a profit, they’re able to distribute a portion of this profit to shareholders. Any part of the profit that is not taken out as dividends is re-invested into the company. If a company does not make a profit, it is not possible to give out dividends.
Salary vs Dividend | Taking Income from your Business
Dividends: The reason why many business owners lean towards paying themselves in dividends is because they offer you a very tax-efficient solution. These are often favourable when compared to the tax put onto salaries. Dividends are usually used in conjunction with a salary with company owners paying salaries just under certain tax brackets and NIC thresholds. The additional funds are then extracted through dividends.
In order to pay yourself through dividends, you’ll need to have enough retained profits in order to cover the dividend amount you wish to pay. You’ll also need to declare the dividend properly and ensure that it is proportionate to shareholdings.
Another reason why people prefer dividends is because they do not attract NIC, as well as the fact that dividends are taxed at a lower rate than salaries. There is also a bracket for tax-free dividend allowances, which is any amount up to £2,000.
Keep in mind: You are only able to take dividends from your post-tax profit. The amount available to you may have already incurred heavy deductions in the form of corporation tax.
In summary, it is a good idea to make use of both dividends and salaries when extracting money from your business, but it may only be possible to start making use of dividends when your business starts making a substantial profit.
Salary: As an owner, manager and company director, it is advisable that you take a monthly salary even if it’s a small one. Taking out a personal allowance of £12,500 (tax year 2020/21) is advisable.
Salary vs Dividend: Advantages and Disadvantages
- When taking out dividends, you can only take them out of your profits;
- Dividends are not as reliable as an income, and you may find it difficult to make long-term financial plans;
- There are no benefits such as maternity leave, pensions etc. associated with taking dividends;
- Dividends are paid after tax deductions, unlike salaries (which are in fact tax-deductible);
- If you mistakenly take out a dividend that cannot be covered by your business’s profits, you would have taken out a director’s loan. And this will need to be repaid; otherwise, you may encounter tax penalties.
- In the years that you take a salary, you’ll be building up to qualify for state pension;
- As you’re technically an employee, you’ll get benefits such as maternity leave;
- You’ll be able to make higher personal contributions to your pension;
- You may find it easier to apply for things like rent contracts and mortgages if you can prove that you have a regular monthly salary;
- By taking out a salary you are able to reduce the amount that your business has to pay in corporation tax as a salary is seen as a business expense;
- You’re able to take a salary even if your business doesn’t make a profit.
- If you take a salary, both you and your business will be subject to NICs (National Insurance Contributions)
- When taking a salary, you’ll be met with higher amounts of income tax.
Final thoughts: There is no ‘one size fits all’ answer to the salary vs dividend discussion. It needs to be considered for each individual, with careful planning to ensure the most tax-efficient decision is made and to ensure that you leave, with the most amount of pay.
Here to Help
As always, the team at FPM are here to help with all your finance and tax queries. For more information and assistance with salary or dividends, please contact our Tax Team.