Salary or Dividend?
Salary or Dividend?
(and why you need to check your management accounts first)
Every accountant in practice today has had this question. It’s a simple enough question, so surely the answer is equally simple? Salary or Dividend? Unfortunately, we live in the UK where the tax system has become so complicated and byzantine that every answer is prefaced with the caveat of “It depends”
“Depends” on what exactly?
Here is a flavour of the tax issues (for 2019/20) that complicate your decision:
- Company profits are taxed at 19%, whereas individuals pay a rate of 20/40/45% according to your total income.
- Individuals have a tax free personal allowance of £12,500, but it disappears once your income tops £100,000.
- Salary attracts employer’s National Insurance Contributions (NIC) of 13.8% and employee’s NIC (12% – plus 2% for weekly earnings over £962). Dividends do not attract NIC.
- The first £2,000 of dividends are tax free, after that they are taxed at 7.5%, 32.5% or 38.1% depending on which tax band you fall into (basic, higher or additional).
- Salary is a deductible trading expense of the company, dividends are not.
Anything else to consider?
I’m afraid so. You also need to consider whether any of the following apply to your circumstances:
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- Top of the list, and this is where your management accounts come in, has the company got enough distributable reserves (i.e. profit from this and all previous years not already paid out as dividends) to at least match the size of the dividend? If not, the dividend is “illegal” and can’t be paid.
- Dividends do not count in accruing your entitlement to state benefits.
- Mortgage providers do not always give the same weight to dividends as salary, treating the latter as (somehow) more secure.
- Tax efficient pension contributions are linked to salary – dividends are not taken into account.
- R&D claims can include relevant salary costs, but not dividends.
- Dividends must be paid according to who owns the shares, unless you want to go down the uncertain routes of dividend waivers or alphabet shares.
So what do I do?
See the first line above – get your accountant to sort it out, he/she does this dozens of times a year and is used to balancing the pros and cons that lead to the “right answer” for you. If you prefer the DIY route, then good luck and at least remember the following:
- Consider the last 6 points carefully e.g. if the company hasn’t got enough undistributed profits then forget about paying dividends until it has. Or if your potential mortgage provider doesn’t really understand dividends, then keep to salary until the mortgage is in place (or find a more savvy mortgage provider).
- Whatever you decide, pay yourself a salary of at least £8,632 pa. This gives you the benefit of a Class 1 stamp without having to pay for it thereby preserving your state benefits. (Bizarre, but true – ask your accountant).
- As a general rule, dividends still come out tops over salary if tax paid is the only factor that interests you.
But don’t forget to make sure you have enough profits to cover the dividend. For new businesses, without several years of trading behind them to build up their reserves, then profits are sometimes paid out as dividends as fast as they are made. But pay out more than the company has earned in profits and disaster beckons – check your management accounts first before making that payment to yourself.
Getting the balance between paying yourself salary or dividend is a complicated calculation that can only be made when you have accurate and regular accounting reports. Find yourself an expert on management accounts who can help you truly understand your numbers.
Great advice from Yorkshire Powerhouse
Now you’ve read our article on paying yourself with Salary or Dividends – have you any more questions?
Here at Yorkshire Powerhouse, we’re happy to help as much as possible – is there anything else we can do to help you, do you have any further questions or can we help introduce you to an expert – please let us know:
Do you know why you are making a profit (or a loss?) - An advice article explaining why a simple set of management accounts will give you the answer! Read >