Running your own small business means making important decisions about how to pay yourself, which can have a significant impact on your financial well-being and tax efficiency.

Salaries and dividends are the two main methods of remuneration, each with its own benefits and considerations. Finding the right balance between the two is key to maximising your financial strategy.

 

Understanding Salaries

Salaries are regular payments made to you as an employee of your company. Here are some key points to keep in mind:

1. Tax and National Insurance Contributions (NICs): Salaries are subject to Income Tax and NICs. For the 2024 tax year, you can receive up to £12,570 tax-free thanks to the Personal Allowance. Any income beyond this amount is taxed progressively.

2. Pension Contributions: Drawing a salary makes you eligible for state benefits, such as the state pension, which is crucial for long-term financial planning.

3. Cash Flow Management: Regular salary payments can help you manage your personal cash flow, ensuring a steady income to cover living expenses.

 

The Role of Dividends

Dividends are payments made to shareholders from the company’s profits. Here are the main considerations:

1. Tax Efficiency: Dividends are taxed differently from salaries. After the initial tax-free allowance of £2,000, dividends are taxed at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.35% for additional rate taxpayers (as of 2024). Importantly, dividends do not attract NICs, making them a more tax-efficient form of remuneration.

2. Profit Dependency: Dividends can only be paid out of profits after corporation tax has been settled. This means that dividends are contingent on your company generating a profit.

3. Irregular Payments: Unlike salaries, dividends can be paid at irregular intervals, offering flexibility in how you receive your income.

 

Combining Salaries and Dividends

Achieving optimal tax efficiency often involves a combination of salary and dividends. Here’s how to approach it:

1. Set a Basic Salary: Pay yourself a salary up to the National Insurance threshold (currently £12,570 for the 2024 tax year). This allows you to benefit from the Personal Allowance and make NIC contributions without incurring Income Tax or NICs.

2. Distribute Dividends: After receiving a basic salary, allocate the remaining profits as dividends. This strategy helps minimize your tax liability, as dividends are taxed at a lower rate than salaries and are not subject to NICs.

 

Practical Example

Let’s say your company’s profit after corporation tax is £50,000.

By paying yourself a salary of £12,570, which is tax-free due to the Personal Allowance, you can distribute the rest of the profit as dividends.

If your total income (including the salary) remains within the basic tax rate threshold, the dividend portion will be taxed at 8.75%.

 

Considerations and Compliance

1. Documentation: It’s important to document salary payments through payroll and declare dividends via proper company resolutions and dividend vouchers.

2. Consultation with Professionals: Regularly consulting with your accountant or financial advisor is essential to ensure compliance with the latest tax regulations and tailor your remuneration strategy to your unique circumstances.

 

Conclusion

Balancing salary and dividends is a strategic decision that can optimize your tax position and financial stability. By setting a basic salary up to the National Insurance threshold and distributing the remaining profits as dividends, you can create a tax-efficient remuneration plan.

Stay informed about changing tax laws and seek professional advice to make well-informed decisions for your small business.

For personalised guidance on structuring your remuneration, reach out to us at Linford Grey. Our experts are ready to assist you in navigating the complexities of tax and financial planning.

 

Why Choose Linford Grey?

Our team of experienced accountants is highly trained, ensuring that we provide expert guidance and support tailored to your specific needs.

By combining our expertise with state-of-the-art technology, we empower our clients to achieve their financial goals more efficiently and effectively.

Whether you are a start-up, a growing business, or an established enterprise, Linford Grey is here to help you navigate the complexities of accounting with ease and confidence.

Get in touch with us today to discover how we can assist you in achieving your financial aspirations and maintaining a robust financial foundation for your business.