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 in England, Wales and Northern Ireland for the tax year 2020/21. Different income tax rates apply in Scotland.
What salary should you pay?
From 6th April 2020 to 5th April 2021 you can pay a total of £8,788 (£732 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?
A tax-free dividend allowance was introduced in April 2016. The allowance for 2020/21 is £2,000. Any dividends in excess of this allowance attract dividend tax. The rate of dividend tax depends on your total income.
Dividends now attract tax at the following rates:
- The first £2,000 of dividends is tax free
- Dividends falling within the basic rate tax will be taxed at 7.5%
- Dividends falling within higher rate tax (£50,000 for 2020/21) are taxed at 32.5%
- Dividends falling within the additional rate of tax are taxed 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 2020/21
- Assume you have the standard personal tax allowance (£12,500)
- Assume you want to take £50,000 income and have no other sources of income.
- You pay a salary from your company of £8,788 on which there is no tax or NI.
- You can pay the remainder of your personal allowance as dividends without any tax, ie £12,500 less £8,788 is £3,712 of dividends.
- Dividends falling within your personal allowance do not count towards your dividend allowance so you can pay another £2,000 in tax free dividends.
Total tax free amount is £14,500 (£8,788 salary plus £5,712 dividends).
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 £37,500 of which you have used £2,000 in dividend allowance.
You can therefore pay another £35,500 of dividends, taxed at 7.5%.
Your total income is now calculated as
- £14,500 as above
- another £35,500 dividends with 7.5% tax of £2,662.50
Total income is £50,000 (£8,788 salary plus £41,212 dividends).
Total personal tax is £2,662.50
Higher rates of tax
If you want to take an income over £50,000, dividend income will attract a higher tax rate. And if your income exceeds £100,000 your personal allowance will be restricted. You should take further advice.
What tax is payable if all the income was taken as salary?
If you were to take all £50,000 as salary, the tax calculation would be very different.
You would pay much more income tax and also large employees National Insurance contributions:
- income tax of £7,500 (£12,500 tax free, then 20% on £37,500);
- employees NI of £5,251 (12% on income between £6,240 and £50,000).
However, the company would pay less tax. Although the company will pay employers NI contributions at 13.8% on salary over £8,788, the company saves corporation tax at 19% on the whole salary (including employers NI). The company’s total tax contribution falls – but by much less than the increase in your personal taxes.
The overall effect is to dramatically increase your total tax bill (taking into account income tax, corporation tax and NI contributions).
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