Pay yourself smarter: The pros and cons of dividends vs salary

As an owner manager, you make important decisions every day. And while a lot of these decisions will be for the financial health of your business, you also need to consider your own remuneration package. We work to live after all.

A remuneration package should align your financial needs with that of your company. If you own a company, the question of whether to take a salary or dividends may weigh on your mind when it comes to planning profit extraction. Both have unique advantages and disadvantages, and it’s important to note they’re not the only options.

While taking a majority dividend approach has previously proven to be beneficial for owner managers in terms of tax, a sharp rise in corporation tax (CT) and a decrease in dividend allowance in the past year means that it may be time to revaluate. Could legislative changes change the way business owners plan their profit extraction? The answer, as Nolan Gooch discusses, depends on yours and your business’s financial standing and your personal goals.

What are salaries and dividends?

Salaries

Salaries are a standard form of payment for a business’s employees. It is often an agreed sum of money paid in often monthly payments of a fixed amount. Salaries are subject to income tax and national insurance; however, this is deductible against a company’s taxable profits.

Dividends

Dividends are payments made to shareholders from a company’s profits after expenses and tax has been deducted. Whilst they are subject to a lower rate of income tax than dividends (see table below), it’s important to note that companies don’t get a tax deduction.

Currently, there is a personal dividend allowance of £1,000, meaning that you can receive up to £1,000 in dividends completely tax-free. However, this reduces to £500 for the Y/E 5th April 2025.

Key business and legislative changes

Corporation tax rates and marginal relief

A major change introduced this financial year was an increase in corporation from 19% to 25% tax for businesses with taxable profits of £250,000 and above. And while smaller profits of £50,000 and below remain at 19%, for those companies who fall between, a marginal relief (currently 26.5%) applies.

Dividend allowance cut

Dividend allowance has been cut from £2,000 to £1,000 and is due to be halved again from April 2024 to £500.

Income tax threshold changes

The threshold was reduced this year for the highest rate of income tax (the additional rate). This is now £125,140 and is down from £150,000, meaning that a higher proportion of high earners will be paying significantly higher tax this year.

Dividend Vs Salary

Dividends for basic rate tax payers

Despite substantial legislative changes, if you’re a basic rate taxpayer and your company has made taxable profits of less than £50,000 paying dividends is most likely to be the best option for you, particularly if combined with a small salary.

Additionally, taking a small salary in combination with dividends will preserve your right for a state pension and other state benefits.

Of course, there is no perfect solution. To receive a dividend your company must have sufficient reserves, and so this requires careful monitoring and foresight when planning. And with the dividend allowance set to reduce further next year, the tax benefits are set to reduce.

Salary

Unlike dividends, you can receive a salary no matter whether your business is profit making or not.

Taking a salary may be beneficial if you are contributing to a personal pension, taking out a mortgage or you want to be considered for any type of loan or credit, as credit providers tend to view a regular salary as a sign of stability.

If you are above state pension age, salary can be more tax efficient than dividends if your company pays tax at 25%. This is due largely to the combined effect of corporation tax relief at the higher rate and you not having to pay employees national insurance.

Taking a bonus

Higher and marginal corporation tax payers

If your company’s profits are subject to corporation tax at the higher or marginal rates a bonus rather than a dividend may be more tax efficient where you have already received a salary of at least £50,270.

The bonus tax treatment is beneficial due to the low level of national insurance payable on the bonus and corporation tax relief at 25% or more.

Salary, dividends and bonus

Despite significant changes to the legislative landscape, for many owner managers the tried and tested route of combining a small salary and topping this up with a payment in dividends remains the most beneficial path to take when planning their profit extraction. However, as we have seen there is some exceptions to this.

As with any form tax planning, it pays to speak to a trusted advisor who understands the nuances of tax legislation and how they apply to your unique circumstances and goals when deciding the best option for you and your company.

Here to support you

If you need advice on the best way to extract money from your company, help is on hand. Our team have expertise in all areas of tax to support you with well-rounded advice.