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Which is best – salary or dividends?

Nearly every business owner I know wants to pay the right amount of tax … and for that to be an efficiently low amount of tax, if at all possible!   There are things you can do inside your limited company to keep your tax bills down and there are ways in which you can organise to pay yourself that will minimise your tax bill.    This article is about paying yourself in a tax efficient way after allowing for the new Social Care Levy – so this is current tax law at November 2021

A lot of people know that paying a small salary and a bigger dividend is a very tax efficient way to pay yourself.  Before talking about that we need to recognise a few important points. 

Firstly, this article is about limited companies that have shareholders so that you can pay dividends.

Secondly, dividends are paid out of profits – so if your business is going through a rocky patch you might not have profits to pay out as dividends.  (In which case, get in touch for a different answer.)

Thirdly, everyone’s circumstances are slightly different and this article obviously gives a general answer, not a specific one for your individual situation.  Getting advice specific to your circumstances might well give a different answer. Get in touch if you would like bespoke advice.

So, what does a tax efficient mixture of salary and dividends mean in 2022?

How much Salary?

I think that the answer is normally to pay yourself a salary equal to the tax free allowance, ie £12,570pa or £1,047.50 per month.   The point of this salary is that it is tax free on you as an individual, and tax deductible on your company – ie both you and your business save tax!  On a salary of this amount you would pay some National Insurance.  The extra Social Care Levy comes into effect in April 2022, and you will pay that as well.  Even with this extra Levy, this is still the most tax efficient way of paying yourself.

How much in Dividends?

For most people paying a dividend of up to £37,500pa or £3,125 per month is best – up to because it depends on the level of profits in your business and you can’t pay more in dividends than you have as profits!  If your business generates more profits, then you can pay more out in dividends.  However, the £37,500pa limit is the point at which you go from 20% into the 40% tax band.  So be aware that paying yourself more in dividends will cost you more in tax.

What about Pensions?

A lot of business owners forget about pension contributions – after all it doesn’t mean money now, but later!   However I think it is very important that every business owner makes pension contributions every month as part of your overall tax efficient remuneration package.   You can do this using the auto enrolment rules or you can ask your pension adviser to help with a bespoke pension scheme.  If you are not sure about this – get the pros and cons from our advisors.

What’s the biggest take-home income: Salary or Dividends?

One of the points about paying dividends is that your company pays a proportion of the tax bill instead of you as an individual.  Whereas, you pay the majority of tax on a salary.  Which means that paying dividends often gives you the biggest take home income.   This is true even with the Social Care Levy and the increase in corporation tax due in 2023.

A note for 40% and 45% taxpayers

If you normally pay tax at higher rates then the Social Care Levy doesn’t change the answer – but the increase in Corporation Tax from April 2023 might!  If this is you, then get our help with some bespoke advice that reflects your circumstances.

So in summary: If you are using a mixture of salary and dividends to pay yourself, then that works now as a way of keeping your tax bills down. It also works from April 2022 when the Social Care Levy is introduced.  But we need to check what it means from April 2023 when the increase in corporation tax happens, especially for higher rate taxpayers.

Feel the need for advice that is bespoke and specific to your circumstances on salary or dividends? Get in touch!

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