Salary or dividends: tax calculations

Contributor -

Elaine Clark

We explain the basics in deciding between paying yourself salary or awarding dividends from your limited company for the tax year. Your personal circumstances will dictate the exact levels and if your finances are complicated you should seek professional advice.

The following calculations are based on rates and thresholds for the tax year 2018/19. However, the dividend allowance and tax percentage rates are the same for 2019/20. The same principals will apply for 2019/20 but using the changed personal allowances and basic rate and higher rate bands. 

What salary should you pay?

From 6th April 2018 to 5th April 2019 you can pay a total of £8,424 (£702 per month) without attracting any tax or NI.

At this level of salary:

  • you get National Insurance Credits towards some benefits e.g. state pension;
  • you must be registered with HMRC as an employer;
  • you must file RTI (real time information) returns each pay period. Fines will be imposed for the late filing of a return.

How much tax will you pay on dividends?

Dividend tax was introduced in April 2016. Any dividends taken over £2,000 for the tax years 2018/19 and 2018/18 will attract dividend tax. This is a significant change from the initial allowance of £5,000 for dividends prior to April 2018 and has increased the tax bill on dividends.

Dividends now attract tax at the following rates:

  • The first £2,000 of dividends is tax free
  • Dividends falling within basic rate tax will be taxed at 7.5%
  • Dividends falling within higher rate tax (£46,350 for 2018/19) will be taxed at 32.5%
  • Dividends falling within the additional rate of tax at 38.1%.
  • For incomes above £100,000 your personal allowance starts to get restricted and therefore the dividend rate bands change.

Example of a dividend calculation for 2018/19

  • Assume you the standard personal tax allowance rate (£11,850 for 2018/19).
  • Assume you have no other income.
  • You pay a salary of £702pm x 12 from your company of £8,424 on which there is no tax or NI.
  • You can pay the remainder of your personal allowance as dividends without any tax, ie £11,850 less £8,424 is £3,426 of dividends.
  • Dividends falling within your personal allowance do not count towards your dividend allowance so you can pay another £2000 in tax free dividends.

Total tax free amount is £13,850 (£8,424 salary plus £5,426 dividends).

Above this amount, assuming no other income, you start to pay tax.

Note - this is per person (consider spouse taking an income or some dividends especially if they do not work elsewhere but always get advice from an accountant first before doing this).

Tax at 7.5%

The next tax threshold is £34,500 of which you have used £2000 in dividend allowance.

You can therefore pay another £32,500 of dividends, taxed at 7.5%.

Your total income is now calculated as

  • £13,850 as above
  • another £32,500 dividends with 7.5% tax of £2,437.50

Total income is £46,350 (£8,424 salary plus £37,926 dividends).

Total personal tax is £2,437.50

Tax at 32.5% and 38.1%

Dividend income over £37,926 will attract tax at 32.5%.

Additional rate taxpayers pay tax at 38.1%.

If your income exceeds £100,000 you should obtain a further advice as your personal allowance is restricted at that level.

What tax is payable if all the income was taken as salary?

Assuming no other income and the basic personal tax allowance applies:

  • salary of £13,850 suffers income tax of £400, employees NI £652;
  • salary of £46,350 suffers income tax of £6,900, employees NI £4,551.

However, there are corporation tax implications for the paying company.

Assuming the company affairs are straightforward, paying a salary attracts employers NI at 13.8% on salary above £8,424 but saves corporation tax at 19% on the whole salary including employers NI.

Conversely, dividends are paid out of post tax profits so the company does not save the 19% corporation tax, but it does not incur the 13.8% employers NI.

The total tax bill is considerably reduced by around £7k in the above examples if you pay the illustrated dividend amounts, but beware, your personal tax situation may be different taking into account other personal and company factors.

How to pay dividend tax on dividends

Unless you are already required to submit a tax self assessment return, you do not need to do so just for dividends below £10,000. Pay the tax due by contacting HMRC and asking for a change to your tax code. You don?t need to do anything if your dividends are within your dividend allowance.

If you already submit a self assessment return, or if your dividends are above £10,000, simply enter the dividend amount on your self assessment tax return

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