Demystifying dividends: a beginner’s guide

For many full-time contractors, the opportunity to earn a higher salary is among their main reasons for making the move. That, along with the freedom and enjoyment that comes with owning their own business.

If you’ve decided to set up your own Limited Company, you want to be certain it’s created in the most tax efficient way. After all, you’ll be working incredibly hard for your money, so you don’t want any more going to the tax man than has to.

Dividends are a great way to maximise the income you take from your business. If you’re not too sure of what they are, here’s an introduction:

 

In a nutshell…

Dividends are essentially a method of taking income from your business. They are payments made to the company’s owners – aka its shareholders – from accumulated profits, after business-related payments such as Corporation Tax and VAT have been made.

The main rule for withdrawing dividends is that your company must have enough ‘retained profit’ in the bank to cover them. Withdrawing dividends from untaxed earnings is illegal and, if caught, you could land yourself in serious hot water with HMRC.

Any profit that remains once you’ve withdrawn the dividends can stay in the account, where the money will hopefully accumulate over time.

 

What are the advantages?

The main benefit of drawing dividends from your Limited Company is that you won’t have to pay National Insurance Contributions (NICs), regardless of your Corporate Tax or Personal Income Tax rates. That’s why many business owners choose to pay themselves a modest salary, topped up with dividends.

 

Are there any disadvantages?

The only real drawback to dividends is that there must be profit in the business in order to declare them. If it’s not turning a profit, you’re still able to pay yourself a salary or bonus, even if it means you declare a loss – a situation you hopefully won’t find yourself in.

Taking dividends is something that must be decided on by every company shareholder, which could cause issues if there were multiple shareholders or an outside investor. Yet, these cases are unlikely to apply to you.

 

Who can dividends be paid to?

Dividends are separate to bonuses and salaries and can only be paid to the shareholders in the business. Many contractors will name a spouse as their shareholder, with dividends split depending on how much share capital each person owns. This can lead to even greater tax efficiency.

 

How are dividends taxed?

Dividends are taxed as personal income. The first £2,000 of dividend income is free of tax under the dividend allowance, with further dividends taxed at the following rates:

Within the basic rate threshold (income between £8,425 and £46,350 for 2018/19) = 7.5%

Within the higher rate (income from £46,351 to £150,000 for 2018/19) = 32.5%

At the additional rate (income exceeding £150,000 for 2018/19) = 38.1%

 

Find out more

Now you’ve got a clearer idea of what dividends are, there are rules to be aware of when it comes to declaring and balancing them with your salary. We thought it would be useful to put together a guide on combining salary with dividends for people making the move into contracting.

If you feel like you might need a helping hand setting up your business, the team at Intouch can help there, too. We’ll pair you up with your own expert Personal Accountant, who will help with everything from incorporating your company with HMRC, to setting up a business bank account, to insuring your company. Make the first step by calling our team today on 01202 375293.

 

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.

 

It’s never too early to plan ahead

It’s never too early to plan ahead

We often get asked about how to be tax efficient when running a Limited Company, and what many people don’t realise is that this also ties in quite nicely with your final exit strategy from your Limited company.  If you take a long term view and plan ahead, you can save a fair amount of tax when you close down…….

Dividend income is effectively tax free in the basic rate band, and then at taxed 25% of the net when you stray into higher rates.  To work out the maximum dividend you can take before those higher rates kick in you simply take the higher rate limit of £41,865, reduce by other income such as bank interest, salary and rental profit, then divide by 10 and x by 9 (this can be slightly more complex when other income or pensions are involved, so ask your contractor accountant to double check your calculation).

 

So £41,865 less your salary of say £12,000 (plus other gross income) leaves £29,865 /10×9 = £26,878.

 

This means you can take dividends of £26,878 tax free, provided the company has the profit available to pay that amount.  You can take the dividend as a lump sum, or break it down into a monthly figure of £2,239.  This can be paid on top of expenses and salary you’re owed.

 

What happens to the rest of the profit that gets left in the company?  That’s the good bit.  Any final profit that is paid out to the shareholders when the company closes can in many cases be paid as a Capital Gain, which, after Entrepreneur’s Relief, is taxable at just 10%.  So you’ll pay 25% on higher rate dividends if you withdraw them year by year, or just 10% if you save the profit in the company to pay out on closure.  Over a few years this could save you a fair amount!

 

Talk to your contractor accountant to find out more details about when Entrepreneur’s Relief is available, and what you can do to plan now for your future.

 

This blog has been prepared by Intouch Accounting. While we have made every attempt to ensure that the information contained in this blog has been obtained from reliable sources, Intouch is not responsible for any errors or omissions, or for the results obtained from the use of this information. This blog should not be used as a substitute for consultation with professional accounting advisers. If you have any specific queries, please contact Intouch Accounting.