This article has been updated for 2016 to reflect recent changes to taxation and accounting. Check out the new article to learn whether dividends are still more tax-efficient than a large salary. What rates of tax do you pay on dividends?
When a small business owner elects to pay themselves a dividend it creates no personal tax liability up to the basic rate tax threshold (typically £40k or so). Once the basic rate has been hit then an effective rate of 25% becomes liable on the net dividend taken. Once this amount reaches the £150,000 limit then the effective rate increases to just over 30%.
How does this compare with income tax on salaries?
Distributions taken as salary are taxed at 20% up to the basic rate band (typically between £10k and approximately £40k) compared to 0% with dividends. Once the basic rate has been hit this rate increases to 40% compared to the dividends 25%. Over the £150,000 band the rate steps up to 45% compared to dividends at 30.56%. In terms of a personal tax liability there is no doubting that dividends are far more tax efficient than salary.
How does this affect the the company's tax position?
Paying a salary also creates an employees and employers national insurance liability; this is not the case with dividends. The salary amount taken is taxed at 12% between £7,696 and £41,444 (2% for amounts over £41,444) for employee national insurance and 13.8% for any amounts over £7,696 for employer’s national insurance.
Salary does have the advantages of reducing your corporation tax (by 20% at the small profit rate and 23% on the higher profit tax rate) on both the gross salary and the employer’s national insurance amounts. But even with that corporation tax saving taken into account the overall tax paid by the company and personally is still far lower through dividends.
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