With changes in the personal allowance, basic rate band, NI threshold and dividend allowance, it is easy to lose track of whether a director working in their own service company would be better paying a larger salary compared to small salary and dividend.
Let’s look at a typical scenario:
If we assume David is a director, worker and 100% shareholder in his personal service company and for 2018-19 David takes a salary of £8,424. The National Insurance threshold is £8,424 for the 2018-19 tax year and so at this level of earnings David pays no tax or National Insurance (neither employee’s nor employer’s) and receives a qualifying year towards the state pension. After taking this salary there is £50,000 left in the company so should David take a bonus or pay a dividend?
Option 1: Bonus Payment
When the bonus is paid the total salary for the year will exceed the National Insurance threshold for both the employer and the employee and so both 12% employee’s NI and 13.8% employers NI will be payable. In addition, the salary will be subject to income tax at a mix of 20% and 40% as the total income will exceed the basic rate band.
In total £6,063 of employer’s NI will be paid, £4,671 of employee’s NI and £9,304 of income tax. As the company has paid all the profits out as a salary and bonus there will be no Corporation Tax to pay.
Option 2: Dividend Payment
A dividend is paid out of profits after the payment of Corporation Tax so 19% tax will be paid on the profits of the company.
When David receives the dividend it will be taxed on him through his Self-assessment tax return. The first part is tax free, using up the remains of the personal allowance and using all the dividend allowance. The next part is taxable at 7.5% and the balance is taxable at 32.5%.
Overall, David and his company will pay Corporation Tax of £9,500 and Income Tax of £3,274.
Comparing the two scenarios
Option 1 – Bonus Payment
Total tax and National Insurance = £20,039 – leaving £38,385 net received by David.
Option 2 – Dividend Payment
Total tax paid (no National Insurance) = £12,774 – leaving £45,650 net received by David.
A saving of £7,264.
Please note there are some other options available to David. He could:
- make company contributions to his pension scheme;
- take a loan (although there are company tax and benefit-in-kind considerations);
- leave the funds in the company; or
- pay rent on assets owned privately but used by the company (but remember to think about capital gains).
If you would like to see how much tax and National Insurance would be payable on your salary versus dividend choices then take a look at our tax calculator for 2018-19.