When you own a limited company, there are two distinct ways you can pay yourself: taking a salary or taking dividends.
Taking a salary as a director
As a company director, you are still able to take a regular salary from your company. Most directors choose to take the same salary as their income tax personal allowance (currently £12,570 per year).
By taking the same amount as the personal allowance, you don’t need to pay income tax on your salary, while still building qualifying years for your state pension.
If your company qualifies for Employment Allowance, it can also be the case that you avoid employer’s National Insurance. All of these combined can mean that paying directors a salary through the company can be overall tax-efficient.
Taking dividends
Dividends can only be taken if the company is making a post-tax profit, as they are a share of profits paid out to shareholders as a return on their investment.
As there’s no National Insurance to pay, it can be more tax-efficient to take money from the company in this way than to take a regular salary.
However, only shareholders are entitled to receive dividends, so company directors who are not also shareholders are not entitled to reap the reward.
How much can you take as a dividend?
Dividends are typically distributed in line with the shareholdings. For example, if a shareholder owns half of the company’s shares, they are entitled to receive 50% of each dividend distribution.
However, limited companies can only offer a dividend if there are sufficient retained profits to cover the dividend after all expenses and liabilities have been settled, while also retaining enough funds to cover the company’s day-to-day expenses.
If the company pays out more than its available profits, the dividend may be deemed illegal, leading to HMRC penalties.
As long as the company satisfies these requirements, there is no regulatory limit on the amount of dividends that can be taken. However, the more money that’s taken through dividends, the more dividend tax will need to be paid.
What is the dividend allowance?
The dividend allowance is the amount of dividends you can earn tax-free above your personal allowance, currently set to £500.
For example, if your combined dividend income and income from other sources is below £12,570, then you won’t pay any income tax or dividend tax.
However, if your income from other sources is £12,570, then you can earn an additional £500 from dividends tax-free. If you earn more than £500 from dividends, then you’ll have to pay dividend tax on the amount above the allowance.
To find out more about the dividend tax bands and how to report dividends to HMRC, check out the HMRC guidance.