Salary v Dividends

One of the many reasons for setting up a Limited Company is to benefit from the tax advantages of paying yourself a mixture of a salary and dividends.

Dividends attract no National Insurance payments. So these are seen as a tax efficient methods of the distribution of the profit from your limited company.

However unless you have income from other sources, then it could be advantageous to pay yourself a salary that utilises your personal allowance - the amount you can earn before you pay tax.

To pay yourself a salary you will need to ensure that the company is registered as an employer.

We suggest that you agree your final payment structure with your accountant before you implement it and the following should be used for guidance only.

Salary

The amount you pay in a salary will depend on your circumstances. In the majority of cases this will be set at a level equivalent to the amount you can earn before you pay tax or national insurance.

The most appropriate salary for you to pay is something you should discuss with your accountant.

There are three options which should be considered:

A salary below the lower earnings limit (LEL).

The LEL is the amount you can earn before you pay national insurance. If a salary is set at this level the company does not need to register as an employer, does not need to run a payroll or compete the employer annual returns.
However this does mean that you do not receive national insurance credits towards a state pension, some benefits etc

A salary equivalent to the 'earnings limit' (EL).
This is the amount you can earn before paying national insurance. At this level no tax or national insurance is due and you do receive national insurance credits towards your state pension and some other benefits.
However at this level the company does need to register as an employer , run a payroll and complete the employer end of year returns.

Above the earnings limit.
At this level tax and national insurance will be due. Again the company does need to register as an employer , run a payroll and complete the employer end of year returns.

The salary paid can be recorded as a cost and can reduce your profit. This in turn will decrease your corporation tax. In many cases this will obviously not be enough to live off.

Dividends

So you can declare a dividend that, together with the salary will be your income from the limited company.

Dividends can be declared when you want. Generally it is suggested that they are paid on a quarterly or half yearly basis but there is no law to prevent you paying them monthly.

Certain rules must be followed when a dividend is paid so as not to make the payment an 'illegal distribution' of profit.

Follow these and you won't go far wrong:

How to work out your dividend

Establish the Company's profits. If you are using the free on line system you will have access to the profit and loss account. This will show the current profit.

From the profit take off:

any dividends already paid in this financial year.
an estimate of the corporation tax due on the profit. If you are using the free on line system the 'Management Information' will give you an estimate of this amount.

The profit after these two figures is what you have available to pay as a dividend - known as 'declaring a dividend'.

The Paperwork

At the time of declaring the dividend, a Board Minute and Dividend Voucher should also be prepared.

See the Guide on Paying Dividends for how to prepare the paper work.