How to pay yourself in a tax efficient way as a company director using dividends
Posted on 9th December 2022
Being a company director is a lot of responsibility, especially if you have employees. You must ensure you’re completing your Company Tax Return accurately and on time so that your business pays the correct amount of tax. You need to register for PAYE for any salaried employees and pay any income tax and National Insurance deducted from their wages through the PAYE system to HMRC. You need to organise pension payments for your employees, along with any employer contributions that need to be made.
And, obviously, you also need to run your business effectively to maximise profitability. Of course, if you’re company is large enough, much of that can be delegated to a suitably qualified and experienced employee – or you can outsource it to a reliable accountancy company ;)
But, as a company director, how do you pay yourself?
You want to ensure your company is as profitable as possible and you want to pay your employees a fair wage. But you also need to earn a living and maximise your own income – otherwise, what is the point in running a business, right?
When it comes to being a company director and paying tax, it can be as simple or as complicated as you want it to be. It can be complicated and confusing because, as a company director, you could have a few sources of income. These different income sources would be subject to tax in different ways and at different rates, and you may need to register for Self-Assessment and/or pay yourself through the PAYE system too.
If you are a director of a small company or SME, you will most likely be a shareholder too – possibly even sole director and shareholder.
You could pay yourself a salary to ensure that you have a regular income coming in from the business, which would make it subject to PAYE if it was above the lower limit for earnings for National Insurance contributions. You would pay income tax and NI contributions on your earnings just like any other employee that is paid through the PAYE system. This would be the simplest way to pay yourself and, so long as the company makes enough money to meet its salary obligations, you have peace of mind knowing that you have the same amount coming in each month. You can always give yourself a pay rise in line with any increase in company profits each year too.
However, as a company director, you are considered an ‘office holder’ in your company, not a regular employee. Because you are an office holder, you are not subject to minimum wage regulations and don’t have to take a salary, although many directors do as it guarantees a regular source of income.
As a director and a shareholder, you could also pay yourself in dividends.
Dividends are payments made to shareholders from the after-tax profits of a company. Because the company has already paid tax on them, dividends are taxed at a lower rate than a regular PAYE salary.
As with anyone earning an income in the UK, you are given a Personal Allowance of £12,570. This means you can earn up to £12,570 per annum before you need to start paying Income Tax on your earnings.
Dividends come with a tax-free Dividends Allowance of up to £2,000, which is in addition to your Personal Allowance.
Once you have used up both your Personal Allowance and your Dividends Allowance, the rate of tax you will need to pay depends on the source of your income.
If you pay yourself a salary through the PAYE system, you’ll be taxed at 20% on anything you earn above £12,570 up to £50,270. For earnings between £50,271 and £150,000 you’ll be taxed at 40%, and anything earned above £150,000 will be taxed at 45%.
With dividends, you’ll be taxed at just 8.75% for earnings from dividends (above the Dividend Allowance) of between £12,571 and £50,270. Earnings from dividends between £50,271 and £150,000 will be taxed at 33.75%, and anything earned from dividends above £150,000 is taxed at 39.35%.
As you can see, choosing to pay yourself through dividends can be a more tax efficient way to take an income from your business. Many company directors opt to pay themselves via a mix of both a regular salary and dividends.
Some things to be careful of
One thing to bear in mind if you choose to pay yourself with dividends as well as a salary is that you would need to register for Self Assessment, as dividends are not taxed at the source like a salary. This can catch some people out as it is assumed that all their tax is paid through PAYE, which is not the case. You would need to declare both your PAYE salary as well as all dividend payments on your Self Assessment tax form.
There are no official rules on when dividends should be paid or how much can be paid, but it is worth remembering that the amount you are able to pay yourself via dividends will vary depending on how much profit the company makes. It is also worth remembering that it’s good practice to retain some of the profit within the business after dividends are paid for reinvestment or to cover cash-flow in case of any future shortfall.
It is normal practice to pay dividends quarterly or every six months. This makes it easier to calculate remaining profit after tax and manage your company’s tax payments and liabilities etc. Paying dividends more often than this can sometimes raise suspicion of mismanaged funds, even if everything is above board and correct.
Are there other ways to reduce my tax bill or pay myself more tax-efficiently?
Paying into a pension is not only good practice for future financial stability, but it can also be a tax-efficient way to save some of your income, too. Pensions can be tricky to navigate when it comes to Self Assessment and taxes though, as they are eligible for tax relief. But depending on the type of pension, tax will be dealt with very differently, so it is important to know what type of pension you are paying into to ensure your Self Assessment form is correct. If you get it wrong, you could end up paying too much tax or too little.
As the director of a company, you are also entitled to certain tax-free benefits. But this is a very complex area with a lot of different rules governing what is a benefit and what benefits are tax free and what benefits are taxable.
You could also take out a director’s loan from the company, but this would need to be repaid otherwise it’ll be considered by HMRC as income from the business and you would need to pay tax on it.
There are numerous ways in which you can take an income from your company as a director in a tax efficient manner, but there are also numerous rules and processes that you need to follow to ensure you are still paying the correct amount of tax.
If you require any assistance at all with your taxes or advice on how to maximise your income as a company director and shareholder, get in touch with Abaqus today.
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