The salary versus dividend decision
If you are both a director and a shareholder of your company, should you take extra income as a dividend or as a bonus? You can often save money by paying dividends, but the saving could be marginal and there are other factors to consider in deciding your remuneration strategy.
There are no national insurance contributions (NICs) on dividends, which is what produces the saving. Companies must pay employer’s NICs of 12.8% on a bonus and deduct employee’s NICs of 11% on earnings below the upper earnings limit of £40,040 and 1% on earnings above the limit. Against this saving is the fact that, unlike dividends, salary and employer’s NICs are deductible against corporation tax.
If your company pays corporation tax at the small companies’ rate of 21%, the saving from paying dividends is significant. Say, for example, you have profits of £10,000 out of which you want to pay a dividend or a bonus. A dividend would give you net income of £5,925, compared to £5,230 for a bonus. The saving is much less if your company’s profits are more than £300,000, so that it pays corporation tax at the marginal rate of 29.75% rate or the full rate of 28%.
Paying dividends may allow profit to be diverted to a shareholding spouse. This could give an additional tax saving if the spouse pays tax at the basic rate. The government intends to restrict this possibility from 6 April 2009, but there is still plenty of time to pay dividends before that date.
Dividends do have some drawbacks however. They have to be paid at the same rate to all shareholders, making them less flexible, though you can overcome this by creating different classes of shares with different entitlements. Salaries can be paid even when the company is making a loss. Dividends can only be paid out of profits of the year or undistributed profits of previous years.
Dividend income cannot support pension payments. Having a low salary may restrict the amount of tax relief you receive when making payments into your pension scheme. And if you are near retirement and your pension will be based on earnings, you may need to enhance your remuneration at least in some years. Dividend income may also be treated less favourably by lenders if you are trying to obtain a mortgage.
We can help you decide which of these and other factors are relevant in your case and devise the best remuneration strategy for your circumstances. Please ask us for our advice.