Dividends Vs Salary: Here’s What to Consider

When it comes to extracting money from a family company by dividends vs salary, there is a lot to think about. This is because HMRC has a tendency to change the rules and regulations on a very regular basis. The truth is when it comes to choosing between dividends or salary, it will depend largely on your individual circumstances as both have different National Insurance contributions (NICs) and tax treatments.

At Newnham & Son, we stay up to date with all the latest news from HMRC in order to help our clients make the best decisions for their companies. With this in mind, when it comes to choosing between dividends vs salary in Hampshire, here is everything you need to know.

Always Think About Other Profit Extraction Methods

While it is important to choose between dividends vs salary in Petersfield, you also need to remember that there are other profit extraction methods available to choose from. For example, if the shareholder directors of your company occupy and own a property, you should also consider paying rent.

Another example would be if there is a directors’ loan balance with a large amount standing to the credit of these individuals, you should consider the option of paying interest on that loan account. With both these examples, no NICs liability applies. Moreover, the dividend tax will not apply either.

In addition to the above, there are also circumstances where it is possible for shareholder directors to take out money from the company in the form of capital. For example, shareholder directors could transfer valuable personally owned assets to the limited company. This could go to the company in the form of goodwill, for example.

If none of the above applies to your company, you will either have to pay remunerations or dividends.

dividends vs salary profits

Understanding the Basic Framework

In an owner-managed business, many see dividends and remuneration as freely interchangeable ways of taking money from a company. However, HMRC treats them very differently for tax purposes. This is because they originally had very different characters.

Remuneration is liable to both employees and employers’ NICs as it is earned income for tax purposes. Unfortunately, with top rates of 12% and 13.8%, NIC on remuneration is very high. With this in mind, many see dividends as a far more attractive alternative.

While this is, in many cases, the most attractive option, the government implemented a surcharge on income taken as dividends. This means that if you are a basic rate taxpayer who is receiving dividends above the £2,000 per person tax-free amount, you will have to pay 7.5% tax on those dividends. If you are in the 40% tax band, you will have to pay 32.2% and if you are in the 45% tax band, you will have to pay 38.1%.

The rates are lower because dividends come from post-corporation tax profits. That said, if it weren’t for NICs, you would be better off extracting your profits by remuneration. In reality, dividend tax takes you above the rate you would normally pay.

The Normal Strategy

While the extra tax implications aren’t ideal for family-owned companies, these still add up to less than if you were to receive these amounts of money as part of your regular income. With this in mind, you should pay some of this money as regular salary. You should then pay the balance of the income taken out of the company by the shareholders as dividends.

There are two reasons for the nominal salary. The first one is that taking out a salary is great for when the personal allowance isn’t used by paying dividends. The second one is that incurring a small amount of NICs by paying a small salary means that the year counts for the purpose of multiple state benefits. Moreover, there is a band of income where you don’t have to pay NICs but the year still counts for NIC purposes.

dividends vs salary strategy

Circumstances Where Dividends Vs Salary Aren’t Interchangeable

When it comes to choosing between dividends vs salary in Hampshire, the two aren’t interchangeable. This is because while one person may be doing a large share of the work and, therefore, earning more income, they may also own fewer shares. As a result, this person would receive fewer dividends despite having put in a lot of hard work.

Another exception is when a person must earn a large amount of income to support a mortgage application. Because certain lenders treat owner-managed businesses differently, they may not lend on the basis of dividends. Unfortunately, they see dividends as investment income rather than earned income. With this in mind, if you are trying to take out a large mortgage you only have two choices. The first one is to take a large amount of remuneration and suffer high NICs liabilities. The second, and best option is to find a lender that views dividends more positively.

Consult With Your Local Accountant to Make the Best Decision for Your Company

Knowing whether to extract income from a company by way of dividends vs salary in Hampshire can be very difficult. With this in mind, it is important that you consult your local accountant in order to better understand the difference between both methods. If you are in Petersfield or its surrounding areas, Newnham & Son can help you with all your business accounting needs.

To find out more about our services and how we can help you, contact us today. One of our team members will be more than happy to help you with any queries.

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