For small company directors in the UK, deciding between taking a salary (payroll) and dividends involves balancing tax efficiencies and personal financial goals. Here's a brief overview of the key considerations:
Payroll (Salary)
Advantages:
Tax Deductible: Salaries are considered a business expense, reducing the company's taxable profits and, consequently, its corporation tax liability.
State Benefits: Earning a salary contributes to your National Insurance (NI) record, which is important for state pension entitlement.
Mortgage and Insurance: Regular salary payments can make it easier to apply for mortgages and insurance policies.
Disadvantages:
Income Tax and NI: Salaries are subject to income tax and NI contributions, which can be higher than dividend tax rates.
Administrative Burden: Managing payroll requires compliance with Real-Time Information (RTI) regulations and regular reporting to HMRC.
Dividends
Advantages:
Lower Tax Rates: Dividends are taxed at lower rates compared to salaries. For example, the basic rate is 8.75%, and the higher rate is 33.75%.
No NI Contributions: Dividends are not subject to NI contributions, making them more tax-efficient.
Flexibility: Dividends can be distributed based on company profits, providing flexibility in income planning.
Disadvantages:
Post-Tax Profits: Dividends can only be paid out of post-tax profits, meaning corporation tax must be paid first.
Profit Dependency: If the company does not make a profit, no dividends can be paid.
Combining Payroll and Dividends
Combining a modest salary with dividend payments can offer the best of both worlds for small company directors. A small salary ensures that directors contribute to their National Insurance record, maintaining their entitlement to state benefits such as the state pension. Meanwhile, drawing additional income through dividends can maximize tax efficiency, as dividends are taxed at lower rates and are not subject to National Insurance contributions.
This approach allows directors to meet personal income needs while minimizing the overall tax burden, ensuring a balanced and strategic financial plan.
Factors Influencing the Decision
Company Profits: The amount of profit available after tax will determine how much can be distributed as dividends.
Personal Tax Position: Directors need to consider their personal tax situation, including their income tax bands and the tax-free allowances.
State Benefits: If maintaining a state pension record is important, a small salary might be necessary.
Administrative Capacity: The ability to manage payroll and comply with HMRC regulations can influence the decision.
Financial Goals: Directors should align their income strategy with their personal and business financial goals.
By carefully evaluating these factors, small company directors can optimize their tax efficiency and ensure a balanced approach to remuneration.
We provide our clients with the optimal structure that's right for them and their business. By planning in advance and completing accounts early, we give our clients flexibility and options in their personal tax planning.
If you think we can help your business, get in touch or call us at 0115 646 2003.
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