Whether you run a limited company or are planning to incorporate, one of the key considerations is how you’ll draw income from your business.
Two popular ways to pay yourself are through a salary or dividends—or a combination of both.
But what exactly are these methods, and which is best for you and your company?
In this article, the experts at IN-Accountancy will guide you through the options.
Please note the accompanying video is from 2023, and employee NICs have reduced slightly since this was published – we will prepare a new version shortly, but not before the Autumn 2024 budget announcements on 30 October this year.
Understanding Salaries and Dividends
A salary is the most common way businesses pay their employees, including directors.
The amount depends on various factors like the business size, the employee’s role, and national regulations such as the minimum wage.
As a company owner, you can choose to pay yourself a salary.
Alternatively, you might opt for dividends, or a mix of both.
Dividends are payments made to shareholders from the company’s profits.
To pay dividends, your business must be a company limited by shares.
Dividends are often seen as more tax-efficient than salaries since they don’t attract employer or employee National Insurance Contributions (NICs).
While salaries have a tax-free personal allowance of £12,570 per year, income above this is taxed at 20% up to £37,700, 40% up to £125,140, and 45% above that.
In addition to the tax-free personal allowance, dividends currently still benefit from a (ever decreasing) non-taxable dividend allowance. More on this later.
To understand more about the different roles and responsibilities as the owner of a limited company, please see our video on this topic here:
Impact of Recent Corporation Tax Changes on Income Extraction
Legislative changes in 2023 and 2024 have affected how company profits and dividends are taxed.
From April 2023, the main rate of Corporation Tax increased from 19% to 25% for profits above £50,000.
While businesses making less than £50,000 taxable profit will benefit from a ‘small profits rate’ of 19%, any profits between £50,001 and £250,000 attract an effective marginal rate of 26.5% which is marketed as ‘marginal relief’…
If a business makes more than £250,000 taxable profit, all profit is taxed at 25%.
The non-taxable dividend allowance was reduced from £2,000 to £1,000 in April 2023, and further reduced to £500 in April 2024. Also, the top income tax threshold was lowered from £150,000 to £125,140.
For more on this subject, watch our video on the subject here:
Balancing Salary or Dividends
Given these tax changes, balancing salary or dividends is key to optimising tax relief. As a director, you can currently draw a salary of up to £758 per month without paying Employers Class 1 National Insurance Contributions (NICs).
Beyond the initial £500 tax-free dividend allowance in 2024, dividends are taxed at:
- 8.75% at the basic rate
- 33.75% at the higher rate
- 39.35% at the additional rate (for income over £125,140)
Additional Methods for Extracting Profits
Aside from salaries and dividends, there are only a few other tax-efficient ways to draw income from your business. These include maximising your employer pension contributions, potentially making tax-efficient loans or having the business buy you other benefits such as company cars or tech, which can be low tax solutions in the right circumstances.
Considerations for Bonuses
Bonuses are taxed at 20% for basic rate payers, 40% for higher rate payers, and 45% for additional rate payers.
Employers pay NICs at 13.8% on earnings above £9,100, while employees pay NICs at 8% on earnings between £12,570-£50,270 and 2% on salaries above this level.
However, businesses can claim corporation tax relief on bonuses and related NICs, potentially saving between 19% and 26.5%.
Conclusion
To achieve the best tax outcome, balance your salary or dividends based on your company’s profits. For personalised advice, contact the specialist accountants at IN-Accountancy today.
