In reality, paying yourself a substantial salary is probably the most inefficient way for a director to pay themselves from a tax perspective, as wages are assessed for income tax at either 20%, 40% or 45%.
Your earnings would also attract both employee and employer National Insurance contributions (NICs), and don’t forget your company will have to pay corporation at 19% on any profits it makes in its accounting period.
For most experienced directors, this isn’t their first rodeo. They know how to take money from their incorporated business as a combination of salary, dividends, and pension contributions in 2021.
That’s the most tax-efficient method right now, even though it involves taking money out of your company for future use, at which point it will be taxed at your marginal rate of income tax in retirement.
But for the purpose of this blog post, we’re going to focus on why extracting dividends from the post-tax profits of your incorporated business can still be beneficial.
How do dividends work in 2021/22?
Everyone has a £2,000 tax-free dividend allowance on top of their tax-free personal allowance (£12,570) in the 2021/22 tax year.
Dividends can count towards your annual personal allowance, as long as your personal allowance has not already been used by other sources of income such as from a salary or pension during the tax year.
If dividends are your only source of income in 2021/22, you can earn £14,570 tax-free. This will be from your company’s profit after all expenses, liabilities, and any deductions for corporation tax and UK VAT.
The basic-rate of dividend tax is charged at 7.5% on taxable income over £14,570 to £37,700. From £37,701 up to £150,000, a higher-rate of 32.5% applies. Dividend income above £150,000 is taxed at 38.1%.
How will dividends work in 2022/23?
Both the dividend and personal allowances will remain unchanged for 2022/23, at £2,000 and £12,570 respectively. So in that sense, it’s very much as you were.
However, the dividend tax rates across all three bands are increasing by 1.25% on 6 April 2022 to help fund the development of the health and social care levy, which kicks in from April 2023.
That means for the 2022/23 tax year, the dividend tax rate associated with the basic-rate band will be 8.75%. The higher-rate will go up to 33.75%, and the additional-rate will increase to 39.35%.
In the grand scheme of things, these new dividend tax rates will still be lower than all of the income tax rates, meaning dividends will remain a tax-efficient way to extract profits from your company.
The most tax-efficient option
Paying yourself a meagre salary of around £8,000 next year will mean you accrue qualifying years towards your state pension, but your company won’t be liable for employers’ National Insurance which is levied at 13.8%.
Let’s say you will receive a dividend payment worth £29,000 in 2022/23. The dividend allowance makes £27,000 of that payment taxable. Add that to your £8,000 salary and your total taxable income will be £35,000.
Once the personal allowance (£12,570) is deducted, the £22,430 remaining will fall into the basic-rate band. That income will attract an 8.75% tax charge (£1,963), leaving you with a net payment of £20,467.
To discuss the most tax-efficient ways to extract profits from your company, email us at email@example.com or call us on 0208 666 0223. And feel free to find out more on our personal tax service page.