Salary vs Dividends: A newbie question

dilby

Hi all -

It's coming up to the end of my financial year for my UK limited company and I have some confusion I was hoping some kind person could help me clear up. I use an accountant but they simply 'do my accounts' and don't really explain things too well. I also want to make sure they are doing things correctly and also to know if I can make changes on my end.

In particular, this relates to cash surplus left in the business account at the end of the tax year and how best to draw it out. I have tried to do research but keep reading conflicting points of view. So please bare with the below....

In the example below, I have £30k (to make it easy) sitting in my business account with a few months left before the end of the tax year, giving me the option to either pay it out as a salary before the year finishes, or to wait and take it as a dividend. According to my (possibly incorrect) calculations...

If I were to take it out as salary:

- I'd be saving £5,700 in corporation tax @ 19%
- I'd be paying £2,700 in Class 4 NIC's (assuming i'd already used up my three threshold).
- Plus I'd be paying £6,000 in basic rate tax @20% (assuming i'd already used up free and starter rates).

So effectively my £30k becomes £27,000 (£30k plus the corp. tax savings, but then minus the others).

If I were to wait and take the £30k out as dividends:

- I'd pay £2,100 in dividend tax (first 2k tax free, then 7.5% after that) And I'd not have to pay income tax or NI contributions.
- So effectively my £30k becomes £27,900.

So according to this, it seems there is actually little difference between the two, despite what I am told from either camp. Should I be limiting my salary drawings to a certain ceiling? I've read in places that I should be only drawing up to £8,632 to avoid Class 4 NIC's (how I'd live off that long term is another matter), and instead rely on dividends as they aren't liability to the same NI contributions. However I'm also aware that by paying myself a salary I am saving corporation tax as it's an allowable expense. I'd like to know people's thoughts on strategies here as it will inform not only this year but my plans for the next financial year and how I draw money out throughout the months.

Any help is greatly appreciated!

Pennywise

Your wrong in thinking about class 4 NIC - they're for self employed (i.e. sole traders). If you take wages, you pay class 1 NIC like other employed staff, and employers NIC. You need to rework your figures using the correct NIC rates.

SonOf

I've read in places that I should be only drawing up to £8,632 to avoid Class 4 NIC's (how I'd live off that long term is another matter), and instead rely on dividends as they aren't liability to the same NI contributions.

Your salary should be to the primary threshold and above that you should take dividends. You are not meant to live on the salary. its just one part of your earnings.

Some take a salary to the personal allowance and dividends above but in most cases, that is not currently the most efficient. However, there isnt much difference at the low end.

You would pay class 1. not class 4 if you exceed the primary threshold.

However I'm also aware that by paying myself a salary I am saving corporation tax as it's an allowable expense.

Yes, you will save on corporation tax of 19% but instead, pay personal income tax of 20% and national insurance. Corporation tax plus dividend tax is lower overall.

The split method is nearly always the best option (caveats apply).

bairn7

You really need the advice of a tax professional as there are several misunderstandings in your calculation.

The flat rate employers NIC (13.8%) on salary adds significantly to the 'tax' burden of a salary (although the NIC will reduce the profits subject to corporation tax).

As advised above, a mixture of both is generally the most-efficient method. You'd want to pay enough salary to qualify for a state pension year but not enough to trigger significant NIC.

Dividends will only be 7.5% to the extent that they fall within your basic rate band. Depending on you other income, they may be taxed at 32.5% or 38.1%.

Much depends on your particularly circumstances, hence why it is worthwhile getting the input of a tax adviser this year. Provided your circumstances don't change dramatically from year 1, you should be able to figure out future years on your own with simply adjustments for changing bands and rates.

polymaff

You've not got the advice you need from your current accountant. That is obvious from your use of terms like "my financial year", "my company", "my business account" etc. etc. The one big mistake just about every one in your circumstances make is to not rigorously separate you, the individual and you the company officer.

It is not a risk, but a racing certainty that disregard of the legal facts will eventually trip you up - not if, just when..:)

That said, the advice you've received in this thread, so far, is very sound. Ironic that you are getting it here for free, when you've paid someone and, apparently got none of this advice in return.

fenwick458

the point about "waiting to take it as a dividend", you don't need to wait.
I just take money out as and when I need it, and the accountant sorts the rest out.
I'd be interested to see the difference if you do decide to work it out. I just do what my accountant said, Salary is the personal allowance / 12 (£1250
0/12=£1040ish)
and the rest as dividends.

00ec25

fenwick458 wrote: »

the point about "waiting to take it as a dividend", you don't need to wait.
I just take money out as and when I need it, and the accountant sorts the rest out.
I'd be interested to see the difference if you do decide to work it out. I just do what my accountant said, Salary is the personal allowance / 12 (£1250
0/12=£1040ish)
and the rest as dividends.

and when the accountant tells you that you now face a s455 tax charge @32.5% because you took more as dividends than the company had reserves from which to pay them?

by all means leave the professional to do the accounts, but at least make an attempt at learning the limits in which you operate.

also, if HMRC got nasty with you during an inspection, and they saw you taking dividends "on a whim" they could convert it to salary and hit you, and the company, for PAYE and employer NI. Monthly dividend? No, prove to me that is not a salary... show me your books

make sure your accountants is producing your board meeting minutes declaring all these dividends you take and the management accounts evidencing the company could afford them at the date you took them. i acknowledge that is an extreme position and that many accountants will "tidy up" at year end, but that still leaves you exposed in year

csgohan4

OP change your accountant, clearly they are little more than book keepers for you and advise you nothing to be tax efficient as ultimately you are ultimately responsible.

fenwick458

00ec25 wrote: »

and when the accountant tells you that you now face a s455 tax charge @32.5% because you took more as dividends than the company had reserves from which to pay them?

I can't see how this is going to happen? I only take money out the the business account if theres money there.

TheCyclingProgrammer

fenwick458 wrote: »

I can't see how this is going to happen? I only take money out the the business account if theres money there.

Money in the bank is not the same as retained profits.

Pennywise

fenwick458 wrote: »

I can't see how this is going to happen? I only take money out the the business account if theres money there.

Presumably after you've ring fenced the VAT and corporation tax due for which you'd need management accounts to calculate.