Using dividends to pay personal tax

Dallybally

Hi. I know this is a question for my accountant, but I think I am missing something really obvious and will look stupid for asking it, so figured I'd look stupid on here instead.


I have a ltd company and pay myself dividends out of it. Come January I'm going to have to take a dividend to pay my personal tax bill (I know I shouldn't be doing it this way but other things have messed up).


For simplicity let's say I need to take 10k. This means next year I will have taken an extra 10k dividend, so my tax bill will go up by £3250 (32.5% of 10k).


If I take dividend again next year, I will therefore need £13250 this time. The year after that I will have to pay additional tax on £13250 and so on.


My question is this, will it ever end? The way I am working it out I will have to pay more and more every year, so in theory it will eventually end up as more than I earn, which obviously is not possible.


If I just took another £1000 a month or whatever I wouldn't have to pay a never ending increasing amount, what am I doing wrong in my calculations?


I'm normally pretty good with these things but just can not get my head around this.


Thanks a lot for reading.

Pennywise

Yes, you're working are right.

Dallybally wrote: »

My question is this, will it ever end? The way I am working it out I will have to pay more and more every year, so in theory it will eventually end up as more than I earn, which obviously is not possible.

Yes, is it possible.

The reason is that you should be saving some of your £10,000 dividend to put aside for the tax and not spending it all.

Taking a dividend causes a tax liability and you should be aware of that and saving it as you go along so you don't need to take an extra dividend to pay the tax on it.

Your £10k you draw isn't all yours to spend in the first place.

xylophone

Why not open a few current accounts that pay interest and make monthly deposits to cover your tax bill?

Dallybally

I have been saving some each month, just not enough. I thought I was going to come into some money but it didn't materialise and I'd spent some of the savings so I'm a bit short.


However, I can't end up owing more tax than I earn, 100% tax. If I'd been taking an additional £833 a month so I had enough saved up, my tax bill for the year would be whatever, but I'd have enough saved up so I wouldn't need to take an additional dividend.


There has to be something in the calculation that balances this. Maybe if I took whatever I would need in the 2nd year out in the 1st year or something?

Pennywise

Dallybally wrote: »

However, I can't end up owing more tax than I earn

Overall, you're not. It's just the timings. You've not /saved paid enough tax in the early years, so it just gets carried forward, but ultimately it has to be paid. It may well be more than 100% in a future year, but that's a timing matter and is a correction of earlier years when you took dividends but didn't save/pay enough tax.

Rather than getting hung up on actual payment dates, look at it over the life of your company and dividend earnings - then you will see that the tax, over the entire period, not just a year, is a relatively small percentage.

It's quite a common scenario/trap you've fallen into by not realising that tax is accruing all the time you're drawing dividends and spending it all rather than saving enough for the tax.

Dallybally wrote: »

There has to be something in the calculation that balances this. Maybe if I took whatever I would need in the 2nd year out in the 1st year or something?

What you need to do is whenever you draw, say, £1,000 in dividends, you need to put, say, £250 of that into a savings account and just spend £750 of it. That way you're limiting yourself to spend only what's yours. By not doing that, you've also been spending the tax on it which you should have been saving/providing for.

Dallybally

Thanks, I think that's what I was trying to get at. There has to be an amount I should have been drawing which included enough savings to pay the tax bill. I just need to work out that amount and stick to it, with enough savings to pay tax.

TheCyclingProgrammer

This kind of poor tax planning is essentially just kicking the can up the road. Your tax liability is always going to keep going up like this. You need to be setting aside the tax on your dividends as you pay them and forget about the money, pretend it doesn't exist. It's not yours.

Depending on how much you need, you could possibly give yourself so,e extra time to make up the deficit by taking a director's loan to cover the tax bill and then paying his off by declaring a dividend at the start of the next tax year, but you'll still need to effectively find the money you should have already put to one side. You'll just have a bit longer to do it as you'll be shifting the liability forward to the next tax year. If you go down this route make absolutely sure you understand the implications of a director's loan and speak to your accountant first.

Going forwards out aside the tax as you go. Keep 100% of the first £5k, then put aside 7.5% until you exceed the other rate threshold, then 32.5%. Don't be tempted to put aside less now and try and make up for it later.

chrismac1

The bit we are missing in this thread is that you do not pay the 32.5% tax if the year-end balance is cleared within 9 months of the year-end. "Clearing" includes things credited to the director's account such as dividends declared and salaries booked to payslips.

It is quite common to owe your companies large sums and not pay any of the 32.5% tax on it. I have one client who has owed his company not less than £70k for every year-end for the past 6, no 22.5% (old rate) or 32.5% tax paid or due, no interest shown by HMRC.

For short term borrowing it makes a lot of sense to borrow from your company if money is "trapped" there due to trying to avoid dividend tax hits. So I have in the past advised clients to use this route in preference to commercial lenders as part of the mix for property deals, where I was confident the resulting balances could be cleared within the 9 months.

No application forms with lots of silly questions, no arrangement fees and rip-off charges for early repayments. And a low interest rate of 3.00% per year, what's not to like?

TheCyclingProgrammer

OP wasnt talking about a directors loan though, they were talking about paying a dividend.

chrismac1

"Come January I'm going to have to take a dividend to pay my personal tax bil."

That was the original statement. What I am saying is that this sin't necessarily so, he or she could simply run up a loan balance without declaring a dividend. At the very least, by declaring the dividend on 6 April 2017 instead of January 2017 the can is kicked down the road by 12 months.

TheCyclingProgrammer

chrismac1 wrote: »

"Come January I'm going to have to take a dividend to pay my personal tax bil."

That was the original statement. What I am saying is that this sin't necessarily so, he or she could simply run up a loan balance without declaring a dividend. At the very least, by declaring the dividend on 6 April 2017 instead of January 2017 the can is kicked down the road by 12 months.

Which is what I said in my post above.

But it depends how much they are going to need as any loan over £10k will need interest paid on it (or incur a BIK charge). Taking a director's loan isn't something that should just be done without being fully aware of the numerous implications.