Salaries vs Dividends – what’s the difference?
Company Owners can reward themselves for their work as a director and their entrepreneurship as a shareholder. As a company director and shareholder you can split your income into salary and dividends to generate income tax as well as National Insurance savings. For example, while National Insurance is payable on salaries, it is not payable on shareholder dividends.
We have created several posts surrounding the small salary, big dividends tax planning technique including potential dangers, non-tax factors and National Insurance for further reading here.
The following points will highlight the major differences between salaries vs dividends for company owners:
Salaries Are Tax Deductible
Salaries can qualify for Corporation Tax relief, dividends however cannot.
For instance, if the company pays you a salary, its taxable profits will be reduced and so it will pay less Corporation Tax.
Dividends are paid out of a company’s after-tax profits, this means paying a dividend does not reduce the company’s tax bill.
Dividends Require Profits
Only companies that generate profits can pay dividends.
Profits are usually calculated when the company’s annual accounts are drawn up, months after the end of the company’s financial year.
So dividends will usually be paid out of profits made in a previous accounting period. It is, however, possible to pay dividends out of profits made during the current year, for example if accurate management accounts are drawn up to determine the level of the company’s distributable profits.
Salaries can be paid even if the company is making tax losses.
Salaries are generally subject to National Insurance, dividends are not. Both the director and the company may be subject to National Insurance.
Salaries and dividends are subject to different rates of Income Tax. Click here to find rates, allowances, tax codes and refunds for Income Tax.
Tax Payment Dates
The Income Tax and National Insurance payable on salaries is collected almost immediately via PAYE. The Income Tax on dividends is collected via self assessment – generally at a later date.
Salaries are classed as ‘earnings’ which is important if you want to make significant pension contributions personally. Dividends are not classed as earnings.
Salaries vs Dividends
By structuring distributions from your company carefully and taking the ‘optimum’ amount of salary and dividends, you could end up with a significantly higher after-tax income than a regular salaried employee who earns a higher income before tax. However, while saving Income Tax will be an important consideration, other factors are important too.
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