When a company makes a profit, it pays dividends to its shareholders.
If you are a contractor or have recently started your own limited company, you have probably heard from other contractors or business owners about taking a low salary and using dividends to make up a portion of your income.
At Tax Agility, our small business accountants work with contractors and small business owners across London. As we are often asked about the advantages of taking dividends from a business’ profit, we aim to discuss dividends in this post.
What are dividends?
Dividends are money paid by a company to its shareholders after it has met its financial obligations (like paying business expenses and taxes). Another way to look at it is that when a company makes a profit, it usually retains a portion of its profit and distributes the rest to its shareholders in the form of dividends.
Why contractors and small business owners like dividends
The main benefits of dividends are:
- Unlike salary, dividends are not subject to National Insurance Contributions (NICs)
- The first £2,000 of dividends are not taxable
- Dividends have a lower tax rate than salaries
For tax year 2019/20, dividend tax rates are:
- 7.5% (up to £37,500)
- 32.5% (£37,501 – £150,000)
- 38.1% (over £150,000)
If you intend to declare dividends, you must hold a board meeting and minute it whenever you make a declaration. Then your accountant will prepare a dividend voucher for each company shareholder stating the net dividend paid.
Prior to the tax year 2016/17, the was something known as a notional 10% tax credit but HMRC has abolished this.
An example of dividend tax
In the tax year 2019/20, you receive a salary income of £8,600 and this is not subject to tax because the income is below the Personal Allowance threshold of £12,500. This also means you still have a balance of £3,900 left to use.
In the same tax year, you receive dividends worth £15,000 and out of this amount, you only need to pay a low 7.5% tax rate on £9,100. This is because:
- £3,900 of your £15,000 dividend income is tax-free since you have this balance from your Personal Allowance (£12,500 Personal Allowance minus £8,600 salary income)
- Another £2,000 of your £15,000 dividend income is also not taxed as you have a £2,000 Dividend Allowance
The upshot of it is you are only required to pay £682.50 tax on your £15,000 dividend income. This low rate is not achievable if you are drawing a salary. You must then declare this dividend income on your Self Assessment tax return in the ‘Dividends’ section.
If you are a contractor, chances are you already know how confusing IR35 can be. If you are considered a “disguised employee” under IR35, you will face severe tax implications. If IR35 is stressing you out, please set up an appointment with us so we can understand your situation better. Alternatively, our post “What is IR35? A brief guide to the IR35 legislation” may make a good read.
Professional advice on dividend distribution
To speak with a professional to discuss how to successfully distribute dividends to your shareholders and to maximise your take-home pay, contact one of our small business accountants in London today. You can call us on 020 8108 0090 or get in touch with us via our contact page to arrange a complimentary, no-obligation meeting.
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This post is intended to provide information of general interest about current business/ accounting issues. It should not replace professional advice tailored to your specific circumstances.