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.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
