If you’re a limited company, the amount of money you pay yourself determines the size of your tax bill. When you pay a salary, this cuts into profits and therefore lowers the amount of Corporation Tax you pay each year. A combination of salary, dividends and bonuses is a way of ensuring you pay yourself enough to live on as an owner-manager or a contractor. But how do you know how much to take in salary and dividends? What’s the most tax efficient way to pay yourself and when do you do it? There are a few different options to consider. Ultimately, your accountant will look at your business closely and advise on the way that best suits you. As the government tinkers with the rules most years, it’s always wise to check before going ahead.
The generally accepted consensus is that the most efficient way to pay yourself is to draw no more than £8,060 in salary (current limit), plus dividends. A salary is deductible against the company’s Corporation Tax bill. This still entitles you to a state pension and a number of benefits. The aforementioned figure comes in under the Personal Allowance threshold, so you don’t pay income tax on it, and it falls below the level for National Insurance Contributions (NICs).
Now, £8,060 may not seem like enough to live on. You bump it up with a dividend. Dividends are company profits distributed to shareholders. That means you need to be making enough profit to pay them out in the first place. Remember that profits are taxed at 20%. That’s Corporation Tax. Dividends are more tax efficient than salaries because there’s a tax allowance here as well. At the moment, it’s £5,000. When you go above that, the dividend is taxed.
The current rate bands are below:
7.5% basic rate
32.5% higher rate
38.1% additional rate
So, staying within the basic rate means you make big tax savings if you’re using dividends in conjunction with a modest salary.
All businesses are different. Some have employees to pay, which means you need to make sure you have enough to run payroll, pay your bills (including your tax bill), and keep cash flow healthy. All of which you need to bear in mind before deciding how much to pay out in dividends. Dividend payments should be top ups to salary.
You can make all this work for you without hassle but always remember one thing: if you get your figures wrong and make a mistake, the taxman will not hesitate to slap you with a hefty penalty. If you want to keep the taxman happy and still pay yourself in a tax efficient way, talk to your accountant first and check that what you want to do won’t get you in hot water with HMRC.