Dividends can be withdrawn when you own a limited company and is one of the main ways that you will get access to the profits that you have made.
Important tax laws about dividends
Whilst this may sound pretty simple – how hard can it be to pay yourself some cash from your business? – there are also important tax laws that concern dividends, and they must be followed properly to avoid any large tax bills and penalties in future.
We’ve noted down some advice here, so that you can pay yourself dividends without paying over the odds for tax.
As with all guidance, this may not apply to your situation.
If you’re unsure about anything, then it’s a good idea to speak to your accountant, who can give you guidance that is tailored to your personal circumstances.
The guidance here is generic, and may not be right for you, so it’s always a good idea to speak to the professionals – like us here at Wagners – who have the most up-to-date knowledge of tax laws.
How much salary should I pay myself?
If you want to make the most out of your income – and pay minimal tax – then you should pay yourself a fixed amount of around £732 a month.
If you do this, and have a standard tax code then you won’t have to pay any form of tax or National Insurance, and you can withdraw any other profits via dividends.
Tax free limit on dividends
If you want to avoid paying tax, then the tax-free limit on dividends is £2,000 in the 2020/21 tax year.
When you go over this amount, you will have to pay the regular taxes associated with dividends subject to the personal allowance of £12,500.
If you choose to pay yourself this salary, then you will still get all of the benefits of a state pension, and some other National Insurance perks.
However, you will have to be registered as an employer, and you need to file a Real Time Information (RTI) return.
This is a totally legal way of paying yourself as the owner/manager of a limited company, and it is a route that many business owners take in order to avoid high taxes.
What is the new dividend tax?
Recently, the laws have changed regarding dividends, meaning that it is a little more complex than before, and some people are paying around 7.5% more tax on any dividend earnings.
However, this is something that most people have discussed with their accountants, and whilst it is a little more complex now than it used to be, you still have personal income tax and dividend allowance whereby you won’t be taxed for all of your dividend payments.
This isn’t anything to worry about, but if you’re still confused about the changes, then it’s a good idea to get in touch with your accountant.
The new dividend tax means different things for different people, and it does depend entirely on how much you’re actually earning, and the salary that you choose to pay yourself.
If you’re not sure how to go about this, then talk to your accountant about what would work best for you.
How much dividends are taxed?
After the £2,000 tax-free limit, dividends are taxed at 7.5% as a basic rate, and 32.5% if you fall into the higher tax bracket.
If you’re in the tax bracket that is above this one – meaning that you earn above £100,000 per annum – then you will be faced with a tax rate of 38.1%.
However, if in the 2020/21 tax year you’re looking to keep your dividends completely tax-free, then you should stick to paying yourself the £732 per month tax-free salary, alongside the £2,000 per annum dividend payment.
Of course, due to the low salary that you are paying yourself, you should only be taxed 7.5% for any extra dividends once the personal allowance of £12,500 has been used up.
This works out to less than the average 20% income tax plus employees national insurance of 12%, so dividends over £2,000 may still be a valid route if you want to pay less tax, whilst still following the legal requirements.
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This 7.5% tax applies to all dividends, when your income is under £32,500.
This means that in the tax year to 5 April 2021, you could have an total income of around £50,000 – a combination of dividends, and the basic tax-free wage of £732 per month – and your tax for the year will be under £3,000.
This is significantly less than you would have to pay if all of your income came from your basic salary alone, so looking into dividends is certainly worthwhile if you’re the owner of a limited company.
Dividend tax rule of thumb
If you want to make the most out of your dividends, then there are a few things that you need to remember. As a rule of thumb, you would get the most out of doing the following:
- Paying yourself a salary of £8,784 per year in the tax year to 5 April 2021, which is tax-free and also not subject to any National Insurance payments
- Using the remaining £5,716 of your personal and dividend allowance to pay yourself tax-free dividends
- Paying yourself up to the total of £41,216 in dividends including the £5,716 above, and only paying £75 of tax per £1,000 (excluding £5,716) that you receive as a result
- After this, the amount of tax that you will have to pay goes up to £325 per £1,000. It is not advisable that you pay yourself this much per year in dividends unless you have a larger profit margin in your limited company, as it could mean that you’re paying over the odds for tax, on cash that may be better off left within your company
- If you’re going to pay yourself over £100,000 in dividends, then it is vital to get in touch with a chartered accountant before you do so, as tax for this amount does become a complex subject
Do I really need an accountant?
Some people prefer to sort out their salaries and their dividends – themselves, but this is something that you should only do if you know the tax laws inside out.
A chartered accountant will always know the most up-to-date laws when it comes to this, and you do take the risk of overlooking something and paying more tax than they need to if you opt to do this yourself.
Using HMRC’s self assessment system
You can do it yourself, however, if this is your preference, using HMRC’s self-assessment system.
If you have an income that falls into one of the later brackets, then it is highly advisable that you go to see a chartered accountant about your income and taxes.
This is because things get a lot more complicated the more you’re earning, and you could make some big mistakes that cost you large sums of money that are difficult to rectify.
Even if you arrange your own taxes and income, seek advice from a chartered accountant or tax specialist like Wagners.
If you want to get the most out of your income, then it is a good idea to pay yourself a salary of around £732 a month, which will be tax-free, and you won’t have to pay any National Insurance, either.
Then, you can top up your salary via dividends, which bring with them a low rate of tax, at around 7.5%.
£2,000 of this is absolutely tax-free, meaning that if you want to avoid tax altogether, then you can draw around £14,500 a year, including your personal allowances.
However, everybody’s personal situation is unique, and this is only general guidance.
If you want to be sure that your accounts are managed properly – and that you’re meeting all of the legal requirements – then you should seek advice from us here at Wagners, as we’re specialists when it comes to tax.
After all, it’s such an important part of your business, so why take the risk of getting it wrong and paying more tax than you need to?
Contact us today, and see what we could do to help you with your dividend and income taxes.