Should I pay myself a salary or a dividend
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Not only does the way you select to pay yourself from a limited company influence your personal income tax, but it also has an impact on many other things. As a director of a limited company, you have the opportunity to select how and when funds are withdrawn from your firm. Several alternatives are available, and the path you take will be determined solely by your income and circumstances. Most directors, on the other hand, take money from their firm in the form of salary, dividends, or a mixture of the two. 

How is a company director paid?

The majority of limited company directors are paid a combination of salary and dividends, frequently supplemented by business pension contributions.

The best combination for you will be determined by a variety of criteria, including:

  • Profits of the firm
  • How much do you want to save on your tax bill?
  • What percentage of the corporation tax bill do you wish to reduce?
  • whether you’re supposed to be within or outside of IR35

Taking a salary

As a director, you may be paid a salary. Most director-shareholders do not have an employment contract since they would have to comply with National Minimum Wage standards if they did. This has ramifications in the event of redundancy.

The benefits of taking a salary

  • Even if your limited company does not profit, you are entitled to pay.
  • You can accumulate qualifying years to qualify for a state pension
  • You can increase your private pension contributions.
  • Salary payment is an allowable business expense, and you can lower the amount of Corporation Tax your limited company will pay through salary.
  • It may be easier to apply for a mortgage, a loan, or insurance coverage. for a critical sickness 
  • If your limited firm employs you and follows the National Minimum Wage standards, you can retain your maternity benefits.

The drawbacks of taking a salary

  • Taking a salary requires the payment of National Insurance payments by both you and the firm (NICs)
  • A salary is also subject to greater income tax rates than a dividend.

What is the tax allowance for salary?

The director receives a salary and is eligible for a pension, sickness, and other benefits. Salary is subject to National Insurance Contributions and Income Tax, removed from your earnings. Please keep in mind that the amount owed will be determined by how much you through your pay.

The salary income tax thresholds for the 2021/22 tax year are as follows:

  • Personal Allowance per year is £12,570.
  • Basic Rate: 20% on earnings beyond the Personal Allowance threshold and up to £37,700.
  • Higher rate of 40% on incomes of £37,701 to £150,000
  • On earnings over £150,000, the additional rate is 45%

What are dividends?

A dividend is a portion of a business’s profits. Profit is the amount of money left over after the firm has paid off its liabilities, including taxes. Dividends cannot be distributed among shareholders if the limited company earns no profit. Because investment income is not subject to national insurance, it is frequently a more tax-efficient way to withdraw money from your firm than obtaining a salary.

How are dividends paid?

Dividends are paid to directors and other shareholders based on the number of shares they own. There is no obligation to distribute all the profit or even some earnings as dividends. Profits can be retained by a business for years and distributed as the board decides. In contrast to paying salaries, a firm must profit (after taxes) to pay dividends. Dividends may only be paid to shareholders as a return for their investment risk. Dividends cannot be paid to directors who are not shareholders of the limited company.

The benefits of drawing dividends

You can significantly lower your income tax burden by withdrawing a portion of your earnings as dividends.

On dividends, neither employer nor employee NICs is due.

In addition to your Personal Allowance, you are entitled to a tax-free dividend allowance.

The drawbacks of drawing out dividends

Dividend payments could only be made from profits; thus, you will not be paid in dividends if your firm does not earn a profit.

Dividend payments, unlike wage payments, are not tax-deductible. Hence it will not help in reducing the corporation tax.

If you take a dividend payment that is not supported by the business’s profits, you have effectively taken out a director’s loan, which you must return.

What is the tax allowance for dividends?

According to the self-assessment period of April 2021/22, The first £2,000 in dividends is tax-free, which is the dividends allowance, after which the basic dividend tax rate on dividends from the limited company is 7.5 per cent which is the basic rate or a higher rate of 32.5 per cent (2021/22) depending on your other income. In addition to your Personal Allowance, you have a tax-free dividend allowance.

Can I take a salary and dividends?

Whether you pay yourself dividends, take a salary, or both will be decided by your circumstances, tax threshold, and income. Most limited company directors find that paying themselves a salary up to the tax-free Allowance and receiving the remainder of their income through dividends is the most tax-efficient way to operate. On the directors’ point, both salary and dividends are personal income for which they are subject to personal tax.

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