Salary or dividends: tax calculations

Contributor -

Elaine Clark

Tax on dividends

Note: the government has announced that from April 2022, tax on dividend income will increase by 1.25%.

When you run a limited company, you can pay yourself with a salary or take an income in the form of dividends - or a mixture of both. We reveal the most tax-efficient options for business owners to take drawings from the business - but if your finances are complicated you should always seek professional advice

What are drawings?

'Drawings' are any money you take from the business to cover your personal living expenses. Drawings are also referred to as salary or wages.

As a start up or small business, you should avoid taking more money from the business than it can afford. You may need to rely on savings until the business is more established and has a steady, positive cash flow.

Make a list of all your regular expenditure and then add to that an amount to cover one-off costs that you only spend now and then. Be realistic with your estimates - don't be tempted to underestimate your living costs just to make your cash flow work!

What salary can you pay yourself without incurring tax?

The following calculations are based on rates and thresholds in England, Wales and Northern Ireland for the tax year 2021/22. Different income tax rates apply in Scotland.  

From 6 April 2021 to 5 April 2022 you can pay a total of £8,840 (£737 per month) without attracting any tax or National Insurance.

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.
  • Bear in mond that you must abide by National Minimum Wage regulations

How much tax will you pay on dividends?

A tax-free dividend allowance was introduced by the government in April 2016. The allowance for 2021/22 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 (£50,270 for 2021/22) 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.

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Planned rise in dividend tax

From April 2022, tax on dividend income will increase by 1.25%. So, after the £2,000 allowance, those in the basic rate band for Income Tax will pay 8.75% on dividend payments (currently 7.5%), while those in the higher rate band will pay 33.75% (currently 32.5%) and those in the additional rate will pay 39.35% (currently 38.1%).

Dividend tax calculation example for 2021/22

  • Assume you have the standard personal tax allowance (£12,570).
  • • Assume you want an income of £50,000 from your business and have no other sources of income.
  • You pay a salary from your company of £8,840 on which there is no tax or NI.
  • You can pay the remainder of your personal allowance as dividends without any tax, ie £12,570 less £8,840 is £3,730 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.

The total tax-free amount is £14,570 (£8,840 salary plus £5,730 dividends).

Note - this is per person (you could consider a spouse taking an income or some dividends from the business, especially if they do not work elsewhere, but always get advice from an accountant first).

Tax at 7.5%

The next tax threshold is £37,700 of which you have used £2,000 in dividend allowance.

You can therefore pay another £35,430 of dividends (taking your total income to £50,000), taxed at 7.5%.

Your total income is now calculated as

  • £14,500 as above
  • another £35,430 dividends with 7.5% tax of £2,675.25

Total income is £50,000 (£8,840 salary plus £41,160 dividends).

Total personal tax is £2,657.25

Higher rates of tax

If you want to take an income over £50,270, dividend income will attract a higher tax rate. And if your income exceeds £100,000 your personal allowance will be restricted. You should then 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 significant employees National Insurance contributions:

  • income tax of £7,846 (£12,570 tax free, then 20% on £37,430);
  • employees NI of £5,251.20 (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 £8,840, 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. You can 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 tax return, or if your dividends are above £10,000, simply enter the dividend amount on your self assessment tax return.

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