The tax rules for dividends changed several years now ago.  As the new tax year has started, we thought we’d detail the most effective 2018-19 dividend and salary combination.

Most efficient 2018-19 dividend and salary combination

This article assumes that you are not a Scottish taxpayer. Scotland has different rates of income tax for non savings income (e,g, earnings). However just to confuse matters the same higher rate threshold applies to dividend income.

Most effective 2018-19 dividend and salary combination: 

New rates

The personal allowance has increased to £11,850 and the basic rate tax threshold has risen to £46,350. Unfortunately though, the dividend allowance has now been reduced from £5,000 to £2,000. You can find further details about tax rates and allowances on HMRC’s website here.

Therefore any dividend income greater than £2,000 will be taxed as follows:

  • If you have any unused personal allowance (£11,850 for 2018/19) then that element is tax free

  • Any dividends in the basic tax band (up to £46,350 for 2018/19) attract a tax charge of 7.5%

  • Dividends in excess of the basic tax band are charged at 32.5%

  • A rate of 38.1% will apply to dividends falling within the additional rate band (income above £150,000 for 2018/19).

As a result of the changes, If you are basic rate taxpayer, and you receive all your income in dividends you will be up to £2,438 worse off!

Most effective 2018-19 dividend and salary combination:

Latest strategies

So now that we know the latest allowances and rates, how does this effect the most effective 2018-19 dividend and salary combination?

Taking a modest salary and the balance as dividends has long been the most tax effective form of profit extraction for limited company contractors, freelancers and owner managed businesses.  The reasoning is as follows:

  • You draw a salary at a level below the personal allowance (so no PAYE is due) though high enough to trigger a national insurance record for your state pension. This is frequently at the lowest level so no national insurance is actually payable).

  • Your company obtains a deduction for the salary in it’s accounts – so corporation tax is saved at 19% of the gross salary paid.

  • Dividends are then declared up to the level of post-corporation tax profit available in the company. However, don’t forget dividends are declared after tax and there’s no corporation tax saving on dividends.

  • No National Insurance is payable on dividends. 

  • As it’s not necessary for your company to pay all post tax profits as dividends in any one year, dividends can be managed keeping your personal tax liability to a minimum.

Essentially there are now two strategies when determining the most effective 2018-19 dividend and salary combination. Which strategy you choose will depend on whether or not you claim the employment allowance.

The Employment Allowance can currently be claimed where there are two directors who are husband and wife.  This may be challenged by the taxman if both husband and wife can’t prove they work actively in the business.

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