As a limited company director, you have greater flexibility to work around the tax system, and are able to implement tax optimisation strategies not available via other business structures. One of these ways is to draw dividends from your company, as opposed to receiving a salary; doing so can help to reduce your tax bill.
If you're newly self-employed, this can be rather confusing. You might be wondering: How can dividends help reduce my tax bill, and what taxes do I need to pay on them? Are there additional considerations I need to keep in mind?
These are the questions we'll be answering below:
What are dividends?
A dividend is a payment of profit that a limited company distributes to its shareholders. This is the money remaining after all business expenses and liabilities, as well as outstanding taxes (including VAT and Corporation Tax) have been paid off.
Dividends must be distributed according to the percentage of ownership of each shareholder. Here's an example: if you own 50% of your company's shares, you will receive dividends amounting to 50% of the retained profit.
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Understanding more about dividend tax
Business owners typically pay themselves through a blend of salary and dividends, as this is a more tax efficient way to operate. That's because neither the company, nor you (as an employee) are required to pay National Insurance Contributions on dividends. You are required to pay tax on dividends though-and we'll explain more about this in the next section.
How much tax do I pay on dividends?
Dividend and personal allowance
For the 2019/20 tax year, a dividend allowance of £2,000 is provided. This means that you only need to pay tax on dividends exceeding that amount.
For the 2019/20 tax year, the personal allowance is £12,500. Do note that the tax rates and thresholds stated in the table below apply after your personal allowance is taken into account.
Dividend Tax thresholds
Here's a simple example to help you better understand how the taxes are calculated. For the 2019/20 tax year, a self-employed individual earned a salary of £12,500 and dividends amounting to £50,000. The table below shows the tax calculations and total tax payable.
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Dividend paperwork: Getting it right
You'll need to produce the following documents for every dividend payment your company makes:
- Board meeting minutes: Companies are required to conduct a board meeting to declare dividends, and company board minutes must be prepared each time a declaration is made. For smaller companies, this may often be just a case of getting the paperwork completed.
- Dividend voucher: A dividend voucher must be issued for every dividend payment made. You need to keep a copy of the voucher for your company's records, as well as provide a copy to each recipient. The voucher should include the following details: company name, date, names of shareholders being paid a dividend and the amount of the dividend.
Additional points to note
Dividends can't be paid out if a company is losing money
Dividends can only be paid on profits that a company has earned during the year, or from accumulated profits from previous years. On the other hand, salaries can be paid out even when a company has made a loss.
Paying a dividend doesn't reduce your company's corporation tax bill
Companies pay Corporation Tax on its profits before dividends are distributed, so paying a dividend doesn't affect your company's corporation tax bill. On the other hand, salaries are considered as business expenses. These reduce your profit, and subsequently your Corporation Tax.
Creating different classes of shares can be an option worth exploring
Does your company have working and non-working partners? Creating different classes of shares may be an option you might want to explore, so that both types of partners don't wind up receiving the same dividend rate.
Timing is key
In general, companies distribute dividends every quarter or half year. There aren't any hard and fast rules when it comes to how often dividends are paid out-and this is something your need to consider carefully. That's because:
- It can have an impact on the amount of tax you pay: Dividends can be a way for you to balance out your profits from one year to another, so you can avoid being put into a higher tax bracket. If your profits are £55,000 in the first year and £10,000 in the second year, you can declare a lower dividend for the first year so that you pay the basic rate for both years-rather than paying the higher rate for the first year.
- It can have an impact on your HMRC deadlines: Income tax on dividends are due in January after the tax year (running 6th April - 5th April) in which the dividend was distributed. This means that tax on a dividend received in February 2019 will be due in January 2020. If the dividend was paid out on May 2019, the tax will be due in January 2021.
Your personal pension can be affected
Receiving income as dividends (rather than a salary) can help reduce your tax load. Yet, it's important to keep in mind that your personal pension will be affected, as getting a salary increases contributions that can be paid into your personal pension.
We recommend checking in with your accountant about minimum salary requirements that may be imposed if you want to make contributions to a personal or executive pension plan. You may also want to discuss whether setting up a company pension scheme is an option you should consider.
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