Salaries and Dividends For The 2020/21 Tax Year

Monday March 16, 2020

If you operate your own UK limited company you will probably want to use the tax planning strategy of extracting money from your company through a combination of dividends and a low salary to ensure you optimise your tax.

So, how are salary and dividends taxed?

For the 2020/2021 tax year the personal allowance is £12,500 – this means your first £12,500 of income is tax free.

If your only income was your salary then any additional salary above £12,500 would be taxed at 20%, and then once you hit the higher tax band of £50,000 any additional salary would be taxed at 40%.

There are further thresholds and tax issues to be aware of, but we’ll keep it simple for this article.

With regards to dividend income, the tax-free dividend allowance for 2020/2021 is £2,000.

For the 2020/21 tax year, the tax on dividends over and above £2,000 is calculated as follows:

  • Any dividends in the basic tax band (£2,001 to £50,000 for 2020/2021) attract a tax charge of 7.5%
  • Dividends above the basic tax band (over £50,000) are charged at 32.5%

It might help to look at a very simple example – if your only income was dividend income – you could receive £14,500 of tax free dividend income in 2020/2021. This is due to both your £12,500 personal allowance and also the £2,000 dividend allowance.

Tax efficient dividend and salary structure

For limited company business owners, taking a low basic salary with the balance of income being taken as dividends is a common tax planning strategy.

This works as follows:

  • You take a low tax efficient salary no higher than the personal allowance so that it does not attract personal tax
  • The salary is a tax allowable cost for your business so corporation tax is saved on the gross salary
  • Any additional amounts you extract from your company (apart from expenses) are treated as dividends which do not attract national insurance
  • Dividends are not treated as a tax allowable expense (unlike a salary) so your company does not save corporation tax on the dividends.
  • Dividends can only be paid from profit made in the company, so if you do not make a profit, you can’t take dividends.

Many people choose to limit their total income to not go into the higher tax band (£50,000 for 2020/2021) so they are not taxed at the higher levels of tax, but this will be a personal choice and a balance will need to be made between tax efficiency and how much of the available profits in your business you want to extract.

Below we have outlined two salary and dividend options which are put together on the basis that you wish to stay below the higher tax band (£50,000).

We have assumed the following when preparing these calculations:

  • You are a UK resident
  • You have no student loan balance
  • Your only income is your salary and dividends from your company
  • You have a standard personal allowance
  • Your company has sufficient post tax profits to support these dividends


Option 1

Take a salary below the national insurance threshold of £8,788 for 2020/2021

This level of salary will not attract any personal income tax or national insurance.

For this illustration we will assume you wish to take £50,000

With regards to dividends, the higher tax band is £50,000 so assuming you want to stay in the basic tax band this leaves you with £41,212 of dividends to take.

There will be some personal tax to pay on these though – the first £2,000 is tax free (dividend allowance) but after that they are charged at 7.5% tax.

Your annual salary is £8,788 so this leaves £3,712 of dividends that can be taken tax free in the personal allowance (£12,500 less £8,788).

There will however be Corporation Tax to pay due to less salary being taken.

The next £2,000 of dividends are also tax free as they are within the dividend allowance.

This leaves the balance of dividends of £35,500 taxed at 7.5% = £2662 of tax.

See below for illustration.

 

2020 / 2021 Tax Year

£ Income

Gross Salary

8,788

Dividends

41,212

Total gross income

50,000

Corporation Tax on £3,712

(705)

Tax on dividends

(2,662)

Net cash for you to keep

£46,633

 

Option 2

Take an annual gross salary of £12,500 which is the standard tax free personal allowance for 2020/2021.

This level of salary will not attract any personal income tax, but it will attract some Employees National Insurance which will total £360 (rounded).

With regards to dividends, the higher tax band is £50,000 so assuming you want to stay in the basic tax band this leaves you with £37,500 of dividends to take (£50,000 less £12,500)

There will be some personal tax to pay on these though – the first £2,000 is tax free (dividend allowance) but after that they are charged at 7.5% tax.

See below table for illustration

 

 

2020 / 2021 Tax Year

£ Income

Gross Salary

12,500

Dividends

37,500

Total gross income

50,000

Employee National Insurance

(360)

Employer National Insurance

(512)

Tax on dividends

(2,662)

Net cash for you to keep

£46,466

Please note if you have employees the employer national insurance may be different if you are able to use the £3000 allowance, and could increase your net income to £46,978.

 

As a further comparison if you were employed on this salary, your income and tax would be as follows;

2020/ 2021 Tax Year

£ Income

Gross Salary

50,000

Personal Allowance

12,500

National Insurance

(4,860)

Income Tax 20%

(7,500)

Net income for you to keep

37,640

 

As always, if you have any questions, please talk to us at RIFT Accounting and we will help you to decide which option will work best for you.

 

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