As an owner of a limited company, often the most tax-efficient way of paying yourself is through a mix of a small salary and dividends. The small salary is usually set to minimise income tax and National Insurance.
For the 2017/18 tax year a tax-efficient salary would typically be between £8,165 and £11,500 for the majority of people. For guidance on choosing the best salary for your directors, take a look at our guide on choosing a tax efficient salary.
What are dividends?
Dividends are a distribution of profits by a company to its shareholders. Dividend payments must be taken after corporation tax on the company profits is accounted for.
By taking a small salary, you ensure that your National Insurance contributions are up to date and you are tax efficient by taking the rest of the profits you make as dividends.
Why dividends are tax efficient
Dividends attract 19% Corporation Tax (tax paid by the company), but no National Insurance and less Income Tax (tax paid personally) than a standard salary.
So after the company pays 19% Corporation Tax, typically in the 2017/18, a basic rate tax payer (with a personal taxable income* of £45,000 or less) will pay around 7.5% Income Tax on the dividends received; a higher rate tax payer (with a personal income* of more than £45,000) will pay around 32.50% Income Tax on the dividends received.
The tax band applies to your income after your tax allowances and any reliefs are taken into account, so you need to allow for your personal allowance as in the equation above. As dividend income is added to your other taxable income and taxed last, you pay tax on dividend income based on your highest income tax band. As you have a dividend allowance of £5,000 you will only be taxed on amounts above this allowance.
The tax to pay on income (including the dividends you pay yourself) is calculated at the end of the tax year via the self assessment tax return and paid by the individual personally. If you are a higher rate tax payer, that means you will need to make provision for the income tax on the dividends at the end of the year calculated through self-assessment. You can keep track of this throughout the year using our Tax calculator.
When can you pay dividends?
You can distribute dividends any time and at any frequency throughout the year, providing there is enough profit in your company (and available cash) to do so. From an HMRC perspective, you need to ensure that, all the dividend payments are covered by the company profits net of corporation tax. This means that you can withdraw dividends at any time as long as there’s enough profit available in your company. So what does this look like from a contractor or consultant’s point of view?
Income (minus the VAT if you are VAT registered) from contracts outside of IR35**
Less Expenditure (salary, NIC, all business expenses)
= Taxable profit
Less Corporation Tax @19%
=Maximum dividend available for distribution to shareholders
**A note on IR35 – Dividends cannot be taken on contracts falling within IR35. You must take all the income earned from these as salary. For more information on IR35, look at our IR35 guide. Any income from contracts falling inside IR35 must be treated separately.
Most contractors and small business owners pay dividends frequently throughout the year. All you need to do is ensure that the dividends you distribute are covered by the profits net of expected Corporation tax and that you leave enough cash within the business as operating capital to meet your future outgoings.
How do you pay dividends?
Every limited company has to ensure that they document and pay dividends appropriately. Here are the typical steps that are required before a dividend can be paid. This can be onerous if you have to produce the documentation yourself.
- Calculate the company profit available.
- Calculate the cash available and any requirements for operating capital.
- Hold a director’s meeting and produce minutes documenting the dividend payment decision.
- Print and retain the minutes.
- Produce a dividend voucher detailing the dividend payment.
- Pay the dividend.
You can create a dividend and download the minutes and dividend voucher detailing the payment with a few simple clicks. Then all you need to do is make the payment to the shareholders.
We’re always here to help
By structuring your personal income using a blend of salary and dividends, you can look to optimise your household income through appointing shareholders and employing family members. If you’re paying dividends for the first time and you want us to check your figures, just call your Account Manager who can run through any questions you may have.
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