Salary or Dividends? The Most Tax-Efficient Split for a Director

How directors actually get paid: why the small salary exists, what a dividend really costs once corporation tax is counted, and the director's loan trap that catches people every year.

Once you have a limited company, the money in it is not yours until you take it out properly. There are three legitimate routes — salary, dividends and expenses — and getting the mix right is worth more than most of the other planning a small company does.

Why the small salary exists

Almost every owner-managed company pays its director a modest salary rather than none. It does two things. It keeps your National Insurance record intact, so the year counts towards the state pension. And it is deductible against corporation tax, where a dividend is not.

The right figure depends on your thresholds and on whether the company can claim the Employment Allowance — a single-director company with no other employees generally cannot, which changes the answer. This is worth getting checked rather than copying a figure from a forum.

What a dividend really costs

Dividends look cheap because the rates are lower than income tax and there is no National Insurance. But they are paid out of profit that has already borne corporation tax, so the honest comparison is the combined cost:

Add corporation tax at 19% underneath and the total is still usually below the equivalent salary once both National Insurance contributions are counted. The gap narrows as profits rise into the 25% corporation tax band.

The rules people break

Declaring dividends with no reserves

A dividend can only be paid from accumulated realised profit after tax. Paid without it, the dividend is unlawful and HMRC will treat it as something else — usually salary, or a loan. Check the figures before declaring, and keep a board minute and a dividend voucher for each one.

Using the company account as a current account

Money taken out that is not salary, dividend or expense is a director's loan. If it is still owed nine months and one day after the year end, the company pays 33.75% of the balance to HMRC. You get it back when the loan is repaid, but not quickly. A balance over £10,000 also creates a benefit in kind unless you pay interest at the official rate.

Forgetting the personal return

Dividends are taxed on you, not on the company. They go on your Self Assessment return, and the tax is due the following 31 January — which for a director paid mostly in dividends can be a large bill arriving nine months after the money was spent. Set it aside as you draw it.

Getting help with this

AJH Accountants handles limited company accounting for clients across the UK. We file the return, tell you what you can claim, and deal with HMRC on your behalf, so nothing depends on you remembering a deadline.

See how our limited company accounting service works, or send us a quotation request and we will call you back. You can also call the office on 01204 840303.

Originally published at ajhaccountant.co.uk/blog/salary-vs-dividends-director-tax-efficient-split.