Best dividend and salary mix for the 2017-18 tax year

The rules for taxing dividend income changed significantly in 2016-17.  You can see our blog on this here.  So with the new rules now firmly in place, what's the best dividend and salary mix for the 2017-18 tax year?

Best dividend and salary mix for the 2017-18 tax year

Best dividend and salary mix for the 2017-18 tax year

Current Tax Rates:

As a starting point, this article assumes you're not a Scottish taxpayer as Scotland has powers to set its own tax rates and has set a lower higher rate band than the rest of the UK.

So what are the headline figures for the 2017-18 tax year?

Well, the personal allowance has increased to £11,500 and the higher rate band is now £45,000.  You can see the relevant rates on HMRC's website here.

This means that if you are a company director, and you take all your payments from the company as salary, then you will receive £11,500 tax free, the next £33,500 will be taxed at 20% and any additional salary will be taxed at 40%.

So if you take a salary of £54,000 you will pay tax as follows:

Salary

Tax Rate

Tax Payable

£11,500

0%

£0

£33,500

20%

£6,700

£9,000

40%

£3,600

Total

£54,000


£10,300

Dividends are taxed differently.  The new dividend allowance means the first £5,000 of any dividend are tax free - no matter what your other income.

Any additional dividend is then taxed as follows:

  • If there is any surplus personal allowance (£11,500 for 2017-18) then any dividends covered by this are effectively tax free
  • Any dividends in the basic rate tax band (from £11,500 to £45,000) are taxed at 7.5%
  • Any dividends in the higher rate tax band (above £45,000) are taxed at 32.5%
  • Additional rates of tax apply if your income is above £150,000

So, using the example above, let's assume as well as a £54,000 salary, you also receive dividends of £20,000.  The first £5,000 of these dividends will be tax free whilst the remaining £15,000 will be taxed at 32.5% as the salary paid has meant you are already a higher rate tax payer.

Best dividend and salary mix for the 2017-18 tax year

So now we know what the new rules are, what is the best dividend & salary mix for the 2017-18 tax year?

For most small limited companies, contractors and freelancers, the most effective tax structure is to take a low salary with the remaining income taken as dividends.  So why this structure?

Well the theory is as follows:

  • You take a salary between the Primary Threshold (PT) for National Insurance (currently £157 per week) and the personal allowance (currently £11,500)
  • By paying a salary at the PT limit you trigger a National Insurance record and therefore maintain your national insurance contribution history which helps  safeguard your state pension however unless you go above this amount you won't need to pay any Employee's National Insurance
  • If you pay a salary higher than the PT limit, then unless you are entitled to the Employer's Allowance you will have to pay some employers NI (many business owners therefore prefer to keep their salary to the PT level as there is less admin involved)
  • If you pay a salary higher than the PT you will also have to pay some employee's NI
  • Any salary paid (and any Employer's National Insurance) is deductible against your corporation tax bill so corporation tax is saved at 19% (the rate for 2017-18)
  • Any additional income is taken as dividends (remembering that dividends are paid after corporation tax so there is no deduction for dividends when calculating your corporation tax bill)

How much you then take as dividends will depend on how much profit is left in the company (you need to avoid an illegal dividend) and your own personal circumstances.  Many business owners prefer to keep their total income below the higher rate band (£45,000) to minimise the tax they pay.

Below we show the best salary & dividend mix with no Employer's Allowance and with the Employer's Allowance.

For both examples we have assumed the following:

  • You are a UK taxpayer - but not a Scottish taxpayer
  • You have a full personal allowance of £11,500
  • You have no income other than the salary and dividends shown in the examples
  • You have no student loans
  • Your company has enough profits to pay the dividends referred to
  • You are not caught by IR35

Option 1: Best dividend and salary mix - salary at the NI Primary Threshold

We'll assume you take a salary of £8,164 (the National Insurance Primary Threshold for 2017-18) so that no employer's national insurance is due.  This keeps things simpler as you don't need to make any payment for NI to HMRC and might also be a better strategy for you if you can't claim the employment allowance (read our blog here for the changes to the allowance and when we recommend you do, and don't claim the allowance).

You may then decide to take dividends up to the higher rate band so that you don't have any higher rate tax to pay on your dividends.

So, if we assume you want to keep your total income to £45,000 for 2017/18 this would result in a dividend of £36,836.

The dividend tax calculation would be as follows:

  • Salary £8,164
  • £3,336 of personal allowance to set against dividend income (£11,500 less £8,164)
  • £5,000 dividend allowance tax free
  • £​28,500 (dividend £36,836 less £3,336 personal allowance less £5,000 dividend allowance) taxed at 7.5% - so tax payable of £2,137.50
  • Net income £45,000 less £2,137.50 tax = £42,862.50

Option 2: Best dividend and salary mix - salary at personal allowance

We'll assume you take a salary of £11,500 (the personal allowance limit for 2017-18) so that a small amount of Employer's National Insurance is due.  We'll also assume you can't claim the employment allowance (read our blog here for the changes to the allowance and when we recommend you do, and don't claim the allowance).

As well as employer's NI of £460.37 you will also have employee's NI to pay of £400 (rounded).

You may then decide to take dividends up to the higher rate band so that you don't have any higher rate tax to pay on your dividends.

So, if we assume you want to keep your total income to £45,000 for 2017/18 this would result in a dividend of £33,500.

The dividend tax calculation would be as follows:

  • Salary £11,500
  • £5,000 dividend allowance tax free
  • £28,500 (dividend £33,500 less £5,000 dividend allowance) taxed at 7.5% - so tax payable of £2,137.50
  • Employee's National Insurance of £400
  • Net income £45,000 less £2,137.50 tax less £400 Employee's NI = £42,462.50

However this does not take into account the saving that the company will make as there will be a higher salary and NI deduction to set off against its corporation tax bill than in Option 1.

This saving will be as follows:

  • 19% of the additional salary - £11,500 less £8,164 = £3,336 * 19% = £634 (rounded) less
  • Employer's NI payable less corporation tax saving on this additional NI = £460 (rounded) less £87 (rounded) = £373

​This gives a net saving of £261 (rounded).

So in comparison to Option 1, you are slightly worse off in Option 2 by £139 - though only if you are unable to claim the employers NI allowance . 

If you were entitled to the Employer's NI Allowance, then Option 2 would mean you were overall better off by £234 (as there would be no Ers NI to pay).

The table below gives you an overall comparison of the tax savings - both personal and the company:

Best Dividend and Salary Mix for the 2017-18 Tax Year

Annual figures

Option 1

Option 2

Gross salary

£  8,164

£11,500

Dividends

£36,836

£33,500

Total Gross Income

£45,000

£45,000

Less: Employee National Insurance


£     400

Less: Tax on dividends

£  2,138

£  2,138

Net cash in pocket

£42,862

£42,462

Corporation tax saved on gross salary

£  1,551

£  2,185

Net Saving- ER Allowance


£     234


Net cost - No ER Allowance


£     139

However, whilst Option 2 has potentially more savings if you are able to claim the employers allowance, Option 1 is simpler and you end up with more cash in your pocket.

Should you take a dividend above the higher rate limit, then you will face a tax rate of 32.5% or higher (if you tip into the child benefit withdrawal, the £100k tax free allowance withdrawal and the £150k upper tax rate band).

Our eBooks cover this and many other topics.  Check them out here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected]ountants.co.uk.

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