If you’re a company director, one of the most important financial decisions you’ll ever make is how you’ll pay yourself. You do not work the way traditional employees do, and you have the ability to structure your income in different ways, most commonly as a salary, dividends, or a mix of the two. That being said, each option comes with its own set of tax benefits and implications, so it’s important to know how these methods work, what the benefits and pitfalls of each are, and how the result will affect your taxes.
In this guide we’ll look at the key differences between salary and dividends for UK directors, what the tax differences are and how to make the most tax efficient choice.
Salary and Dividends: What Do They Mean?
What is a Salary?
A salary is regular payment for work done. The directors can pay themselves a salary through the company’s payroll system and the PAYE scheme (pay as you earn) is used to process it.
How it works:
The company treats salaries as operating expenses, which reduce its taxable profit. If the director has an employment contract, the director must pay Income Tax and National Insurance Contributions (NICs), and may be subject to minimum wage requirements also.
What are Dividends?
A dividend is payment of a company’s profits to its shareholders. This gives directors who are also shareholders another means to earn income from their company.
How it works:
Dividends can be paid only if the company has enough post tax profits. Unlike salaries, they don’t reduce the company’s taxable profit and aren’t subject to NICs. They are, however, taxed under the Dividend Tax regime.
Salary vs Dividends: Key Differences
Tax Treatment
Salary: Income Tax and NICs payable.
Dividends: They are potentially more tax efficient as they are subject to Dividend Tax but exempt from NICs.
Source of Payment
Salary: Paid no matter what company profit was.
Dividends: Paid depending upon the post-tax profit availability.
Reporting and Administration
Salary: Regularly reported to HMRC through PAYE.
Dividends: Dividends have to be declared at shareholder meetings and documented properly.
Impact on Benefits
Salary: It counts toward state pension and employee benefits.
Dividends: Do not count towards state benefit eligibility.
Tax Implications of Salary in the UK
When you pay yourself a salary, you need to add Income Tax and NICs to that which can make a big difference to your take home pay.
Income Tax
For the 2024/25 tax year, the UK tax bands are:
Personal Allowance: £12,570 (tax-free income).
Basic Rate (20%): £12,571 to £50,270.
Higher Rate (40%): £50,271 to £125,140.
Additional Rate (45%): Over £125,140.
When Directors are paid a salary within the Personal Allowance, Income Tax is avoided but NICs need to be considered.
National Insurance Contributions (NICs)
NICs are applied directly to directors under a special calculation method known as the annual earnings period. For 2024/25:
Primary Threshold: £12,570 (no employee NICs).
Employer NICs: 13.8% on earnings above £9,100.
These contributions can be expensive and it is important to find the right balance between a taxable salary and tax-free dividends.
Dividends in the UK and their Tax Implications
Income from dividends is taxed differently and could yield you savings over income from a salary.
Dividend Tax Rates (2024/25)
Dividend Allowance: The first £500 of dividend is tax-free.
Basic Rate (8.75%): For total income (salary + dividends) up to £50,270.
Higher Rate (33.75%): For earnings between £50,271 and £125,140.
Additional Rate (39.35%): For income above £125,140.
Since dividends are exempt from NICs, they may be a tax-efficient method of obtaining earnings. However, they must be properly declared and dispersed to avoid an HMRC penalty.
Restrictions on Dividends
- Dividends cannot exceed the company’s post-tax profits.
- Dividend vouchers and payments are to be recorded in meeting minutes.
Advantages and Disadvantages of Salary and Dividends
Salary Advantages
- Provides a consistent income.
- Helps towards state pensions and other benefits.
- It is a company expense, which reduces taxable profit.
Salary Disadvantages
- Taxes and NICs are subject to higher rates.
- It increases administrative burden because of PAYE requirements.
Dividend Advantages
- Lower tax rates than your salary.
- Increasing net income not subject to NICs.
- It is flexible about the timing of payments and about the amounts.
Dividend Disadvantages
- Requires enough company profits.
- Does not contribute to pension contributions or state benefits.
- Not planned carefully may attract higher tax rates.
Which Option is Better for you?
There’s no one best choice, and it often depends on your financial goals, company performance, and personal tax situation. Most directors choose to take a mixture of salary and dividends to try and maximise tax efficiency whilst ensuring compliance with UK tax laws.
Compliance and Legal Considerations
- Stay Compliant with HMRC: Get salaries processed right under PAYE as well as declare dividends appropriately with the appropriate documentation.
- Avoid Illegal Dividends: Directors can be liable to penalties and repayment under concerns for paying dividends where such dividends are not paid out of sufficient post-tax profits.
- Seek Professional Guidance: Tax laws are complex and are changing all the time. Using an accountant for tax returns means that you stay compliant and take advantage of the allowances available to you.
Conclusion
As a director, you have to choose between salary or dividends and you need to take into account your personal financial goals and your company’s performance. Dividends are tax efficient, but salary is stable and gives you access to state benefits. However, this often means that you can take advantage of both the good and the bad, minimising tax liability.
By making informed decisions about director pay you save yourself money and ensure compliance with UK tax regulations. So that’s where our team of expert tax accountants come in — we help directors like you to optimize your income structure.
Contact us today to schedule a consultation and our team of tax return accountants will work with you to help achieve financial efficiency and peace of mind.