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Dividends vs Salary – Are Dividends Still The Low Tax Option

Thu, Mar 4, 2010

TaxPenny Blog

The examples below explore the tax efficiency of the different ways in which it may be possible to extract profits from your business.

You have the options of:

  • Operating as a Sole Trader (No limited liability, No shareholding ability).
  • Incorporating as a Company (Limited Liability, Ability to hold shares).

For illustration purposes, we will use a Gross Company Profit figure of £200,000. The business owner is a 35 Year Old Male (In order to calculate NIC and Tax Allowances).

2009/2010 Tax Year

SOLE TRADER -

If the entire £200,000 profit is taken as a sole traders income:

£200,000.00 Gross Company Profit before taking Salary
£6,475.00 Personal Tax Free Allowance
£124.80 paid as Weekly Self-Employed National Insurance Contribution
£4,614.05 paid as Class 4 National Insurance (Self-Employed NI)
£69,930.00 paid as Income Tax
£125,331.15 Net Income from £200,000.00 Company Profits
£74,668.85 Total Taxation

37.33% Total Tax (SOLE TRADER)


LIMITED COMPANY(Salary Taken as PAYE)

£200,000 is the gross profit figure, but taking into account employers NI, only £177,954.04 can be taken as salary.

£22,045.96 paid as Employers National Insurance
£177,954.04 New Profit figure (This will be the directors salary, as Employers NI is now paid)
£6,475.00 Personal Tax Free Allowance
£5,539.14 paid as Class 1 National Insurance (Employed NI)
£61,111.62 paid as Income Tax
£111,303.29 Net Income from £177,954.04 New Company Profits
£88,696.72 Total Taxation considering Employers NI of £22,045.96

44.35% Total Tax (FULL DIRECTORS SALARY)

Net Salary £111,303.29 (£177,954.04 GROSS SALARY from £200,000.00 GROSS PROFIT)


LIMITED COMPANY – Dividends Taken along with a small salary via PAYE

£200,000 Gross Profit figure, but £6,475 is taken as a Salary so new Profit figure is £193,428.36 after Employers NI.

£200,000.00 Gross Profit before taking a Basic Salary from it (Up to your tax free allowance)
£6,475.00 Salary taken from Gross Profit
£96.64 Employers NI taken from Gross Profit
£83.05 paid as Class 1 National Insurance Contributions on the Basic Salary (Employees NI)
£193,428.36 new Gross Profit declared
£40,619.96 Corporation Tax on Gross Company Profit
£152,808.40 Net Company Profit
£29,787.10 tax on £152,808.40 NET Dividend
£129,413.25 Total Take Home Pay from £200,000.00 Company Profits after all tax deductions
£70,586.75 Total Taxation

35.29% Total Tax (DIVIDEND)

From the above example for the 2009/2010 Tax Year, it was most tax efficient to use the Dividend/Basic Salary method. With only 35.29% of Gross Profits paid in taxation, as opposed to 37.33% and 44.35% for Sole Trader and Full Directors Salary, respectively.

The 2010/2011 Tax Year – Dividends Vs Salary – Is there still an advantage?

Prior to the 2010/2011 tax year, the maximum rate for dividends was 32.5% and income tax personal allowances were not tapered nor was there a maximum taxation rate of 50% over £150,000.

This year, 2010/2011, there is a new rate for dividends over £150,000 of 42.5%, Personal Allowances are tapered by £1 for every £2 above £100,000 of Gross annual income and over £150,000 of gross income incurs a 50% maximum taxation rate.

Again for illustration purposes, we will use a Gross Company Profit figure of £200,000. The business owner is a 35 Year Old Male (In order to calculate NIC and Tax Allowances).

SOLE TRADER -

If the entire £200,000 profit is taken as a sole traders income:

£200,000.00 Gross Company Profit before taking Salary
£0.00 Personal Tax Free Allowance
£124.80 paid as Weekly Self-Employed National Insurance Contribution
£4,614.05 paid as Class 4 National Insurance (Self-Employed NI)
£77,520.00 paid as Income Tax
£117,741.15 Net Income from £200,000.00 Company Profits
£82,258.85 Total Taxation

41.13% Total Tax (SOLE TRADER)


LIMITED COMPANY(Salary Taken as PAYE)

£200,000 is the gross profit figure, but taking into account employers NI, only £177,954.04  can be taken as salary.

£22,045.96 paid as Employers National Insurance
£177,954.04 New Profit figure (This will be the directors salary, as Employers NI is now paid)
£0.00 Personal Tax Free Allowance
£5,539.14 paid as Class 1 National Insurance (Employed NI)
£66,497.02 paid as Income Tax
£105,917.88 Net Income from £177,954.04 New Company Profits
£94,082.12 Total Taxation considering Employers NI of £22,045.96

47.04% Total Tax (FULL DIRECTORS SALARY)

Net Salary £105,917.88 (£177,954.04 GROSS SALARY from £200,000.00 GROSS PROFIT)

LIMITED COMPANY – Dividends Taken along with a small salary via PAYE

£200,000 Gross Profit figure, but nothing is taken as a Salary (as you have no tax free personal allowance) so Profit figure remains as £200,000.

£200,000.00 Gross Profit before taking a Basic Salary from it (Up to your tax free allowance)
£0.00 Salary taken from Gross Profit
£0.00 only taken as salary due to reduction in tax free allowances (Overall Gross Income in 2010/2011)
£0.00 Employers NI taken from Gross Profit
£0.00 paid as Class 1 National Insurance Contributions on the Basic Salary (Employees NI)
£200,000.00 new Gross Profit declared
£42,000.00 Corporation Tax on Gross Company Profit
£158,000.00 Net Company Profit
£33,640.56 tax on £158,000.00 NET Dividend
£124,359.44 Total Take Home Pay from £200,000.00 Company Profits after all tax deductions
£75,640.56 Total Taxation

37.82% Total Tax (DIVIDEND)

So in the 2010/2011 Tax Year there is an overall increase in taxation between all methods described.

  • Sole Trader will pay 41.13% as Tax in 2010/2011, as opposed to 37.33% in 2009/2010.
  • A Director taking a salary will pay 47.04% as Tax in 2010/2011, as opposed to 44.35% in 2009/2010.
  • A Director taking Dividends/Salary will pay 37.82% as Tax in 2010/2011, as opposed to 35.29% in 2009/2010.

Use your own figures to calculate the differences at our dividend vs salary calculator.

You will receive the full calculations as above, including the correct corporation tax, dividend tax and income tax calculations.

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2 Comments For This Post

  1. Mark @ paye limited Says:

    It’s easier overall being a sole trader/freelancer as you can have multiple incomes and often have the chance to get paid in cash.

  2. SimonP Says:

    In some circumstances, it is also worth considering forming a partnership as a tax saving measure.

    Using the above profit figures, if there are two partners earning £100k each, each partner would have a total tax liability of £33,668.85, ie. £67,337.70, whereas a sole trader would pay £82,258.85 total tax on an income of £200k.

    Now, should the two partners be from the same family, say husband and wife, their joint income would benefit to the tune of £14,921.15 [£82,258.85 - £67,337.70].

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