Pay yourself by dividends and reduce your tax bill!

One of the main tax advantages of running your own company is an ability to decide how you draw money from the business. We are looking here at situations where the directors and shareholders are the same - or family members - and where a pooling of interests (and therefore income) is possible.

This flexibility is important because at different times, the different methods of drawing funds offer tax advantages and disadvantages.

For some time there has been an advantage in structuring director / shareholder benefits to pay a lower salary and take a bigger proportion of income as dividend.

Dividends are the sharing out of taxed profits to shareholders and are normally voted once or twice a year; the same concept applies to dividends from shares held in a FTSE company and may be familiar.

The difference is that you can decide the timing and amount of the dividends, subject to there being available profits. This can have advantages when your company’s financial year bridges two income tax years, allowing you to decide into which income tax year the dividends fall.

Dividends can be paid from the accumulated post-tax profits of the company i.e. not just the current year but any accumulated profits from previous years. The company pays corporation tax on its profits in any one year and the “after tax profit” is added to a pot which can be used for dividends.

A “Director’s salary” is still paid, this being a minimal amount geared to use up your personal allowance and to ensure that you record an National Insurance contribution in order to secure state pension rights.

The dividends which are paid don’t suffer NI contributions in any form – employer or employee – and the saving can be considerable compared to paying a higher salary or if you were self employed (one reason to consider incorporating your business).

In addition, provided you are not a higher rate tax payer (i.e. total income around £43,000) the dividend comes out to you without you having any additional tax liability i.e. effectively TAX FREE. So, the company pays tax at 20% but you pay nothing else.

You also have the ability to give shares to a partner / spouse and so divide the dividend income i.e. if you have a partner who is a basic rate tax payer, the partner can receive some dividends and thus keep your personal income down – you split the dividends between two so that perhaps neither of you reach the higher tax rate band.