Minimising your individual and business tax liability is a vital part of running a profitable business. How you pay yourself – whether through dividends, a salary, or a mix of both – is key to keeping your tax bill to a minimum. Here you can learn if small business dividends is the most efficient way to pay yourself.
What are dividends?
Dividends are payments made to company shareholders based on your company’s profit. They cannot be offset against corporation tax in the same way that salaries can.
Most large businesses pay dividends either once or twice a year, usually as a reward to shareholders for investing in their company.
This amount will vary according to how much your business has made. Shareholders will be paid in accordance with how many shares they own, as each share’s individual value is determined by profit. For example, if your profit is £5,000 for the month and you have 100 shares, each has a value of £50.
The good news is that dividends are not limited to large organisations. As a small business owner, you may choose to pay yourself and any other shareholders dividends each month. It’s a viable option even if you’re the only shareholder, however it’s not possible for sole traders.
Here you can learn the difference between a sole trader and a limited company.
If you receive dividends from your small business, your personal tax liability will be dependent on your overall annual earnings. This will be calculated and paid through self assessment.
Is paying yourself dividends tax-efficient?
The rate of tax you pay on dividends is lower than you would pay through PAYE. The following table outlines the rate of tax you pay personally on dividends against income tax rate, above your allowable tax free income of £11,850:
|Band||Taxable income||Tax rate PAYE||Tax rate dividends|
|Basic Rate||£11,850 to £46,350||20%||7.5%|
|Higher Rate||Up to £150,000||40%||32.5%|
|Additional Rate||Above £150,000||45%||38.1%|
While receiving payment of dividends is more tax efficient for an individual, your company (and that means you, in the case of a small business) will still have to pay corporation tax of 19% on profits before dividends can be deducted. For example, if your business was to make £10,000 profit in a month and you chose to pay this as dividends:
- Corporation Tax: 19% of £10,000 = £1,900
- Tax on dividends: 7.5% of £10,000 = £750
- Total tax payable: £2,650
For most small business owners your company’s profits are your income. That’s why corporation tax is a key consideration when deciding wether or not dividends are the most tax efficient way to pay yourself.
Dividends and a salary at the same time
In some cases, it makes sense to consider receiving both a salary and a limited amount of dividends. Here are the criteria you have to meet to make it a reasonable option.
- Make no more than £11,850 through employment
If your business is claiming Employment Allowance, you can claim back £3,000 of National Insurance Contributions (NIC) each year. Under this scheme, paying yourself an annual salary of £11,850 is the most tax efficient approach, as it keeps you within the annual tax free income allowance threshold. That means you won’t have to pay any tax on your earnings.
If you’re not eligible for Employment Allowance, £8,424 is the most tax-efficient salary to draw this year. This will keep you under the threshold for Employees’ and Employers’ NIC.
In most cases, an annual salary of either £13,850 or £10,424 isn’t going to be enough to live on. This is where you can make up the difference by paying yourself in dividends.
- Withdraw no more than £2,000 of dividends
As a shareholder, you can also withdraw up to £2,000 of tax-free dividends within the financial year. Therefore, by combining your Personal Tax Free Income and Dividend Allowance, you can receive up to £13,850 of tax-free income in 2018/19 (£10,424 for those not claiming Employment Allowance).
You can also offset the amount you pay yourself through your salary against your corporation tax bill, thereby reducing your company’s tax liability. For those companies with more than one shareholder, this is a particularly tax-effective route to take.