Are Dividends more Tax Efficient than Salaries?

Running your own business can be a rewarding experience but it also comes with a unique set of financial considerations. One of these is how to structure your income in the most tax-efficient way. It’s unsurprising that one of the most often asked questions we hear is ‘are dividends more tax efficient than salaries?’ We’ve taken the ‘bull by the horns’ and asked our in-house tax specialists whether this strategy really is more tax-efficient? Here’s what they said!

Establishing the difference is key to the answer!

When it comes to answering ‘are dividends more tax efficient than salaries,’ it’s not a straightforward ‘yes’ or ‘no’ answer. It depends entirely on your unique circumstances and goals.

One of the first things to ask yourself when considering this, is do you actually know the difference? Indeed, the difference between ‘dividends’ and ‘salaries,’ is obvious, right?

As is often the case, the more you think about it the boundaries become blurred. So, we find it useful to think about them as follows:

A salary is considered ‘earned income’ and is subject to income tax and National Insurance contributions (‘NIC’).

Dividends, on the other hand, are considered ‘investment income’ and are subject to different tax rates.

Considering the dividend allowance also informs the answer

The dividend allowance for the 2022-2023 tax year is £2,000. This means that dividends received up to this amount are tax-free. Dividends received above the allowance are subject to tax at 8.75% for Basic Rate Taxpayers (‘BRT’), 33.75% for Higher Rate Taxpayers (‘HRT’), and 39.35% for Additional Rate Taxpayers (‘ART’).

In comparison, a salary is subject to income tax at 20% for BRT, 40% for HRT and 45% for ART, depending on the amount earned. Additionally, NICs are applied to salary income at rates of 12% and 2% (rates increased temporarily to 13.25% and 3.25% respectively between 6th April 2022 to 5th November 2022).

So, on the surface, it might appear that dividends are more tax-efficient than a salary. However, there are a few factors to consider before making this decision.

What else to consider when asking are dividends more tax efficient than salaries?

One important factor is that dividends can only be paid out of profits! So, if your business is not making a profit, you will not be able to pay yourself dividends. You could, however, still pay a salary.

Another consideration is that taking a salary can also help you build up your national insurance record. This is important for claiming certain state benefits in the future, as paying yourself dividends does not automatically contribute towards these benefits.

The low down – are dividends more tax efficient than salaries?

In short, while dividends may be more tax-efficient than a salary in certain circumstances, it is important to weigh all the factors in the round.

The rules and regulations surrounding tax are somewhat ‘shifting sands,’ so it is always wise to seek professional advice from an accountant or tax advisor. They will help you to find the most tax-efficient way to structure your income and ensure that you remain compliant with all the regulations.

As always, if you would like to speak to one of our expert tax-advisers, please do call us on 01243 782423. Alternatively, you can email us from our contact page and someone will be in touch!

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