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Dividends or Salary for Small Business Owners: Which is the Better Option?

By 24/02/2023June 12th, 2023No Comments
Dividends or Salary for Small Business Owners

As a small business owner, deciding how to pay yourself is an important decision that can have a significant impact on your finances. Should you take a salary, dividends or a mixture of the two? In this article, we will discuss the pros and cons of taking a salary or dividends, and help you make an informed decision that’s best for your business.

The Benefits of Taking a Salary: Understanding Your Pay as a Small Business Owner

Dividends or Salary – The Case For Taking A Salary

One of the main advantages of taking a salary as a small business owner is that it helps build entitlement to state benefits and pension contributions. By paying yourself a salary, you can qualify for benefits like statutory sick pay and maternity pay. You also build up your entitlement to the State Pension, which can be crucial in ensuring financial security in retirement.

Another benefit of taking a salary is that it can help to improve your personal credit scores and borrowing potential. Paying yourself a regular salary can demonstrate to lenders that you have a steady income stream and can manage your finances responsibly. Financial advisors or mortgage brokers can look at dividends hesitantly, so it’s often better to weigh your drawings more heavily towards salary if this is something you are concerned about.

Taking a salary can also provide stability and structure to your finances. It can help you to better manage your personal finances and ensure you have a regular income stream. This can be particularly important if your business is going through a period of uncertainty or instability.

The Drawbacks of Taking a Salary: How to Minimise the Tax Burden

Dividends or Salary – The Case Against Taking A Salary

Firstly, taking a salary can result in higher national insurance contributions and income tax, which can significantly reduce the amount of money you take home. Additionally, taking a salary can impact the profits of the business, potentially limiting growth opportunities. Salaries are considered a business expense and reduce the overall profits of the company.

For example, if a business owner chooses to take a high salary, it may result in less money being available to invest back into the business. This could mean missing out on potential growth opportunities or not having enough funds to cover unexpected expenses.

However, the thing that catches the attention of business owners is almost always the tax implications. For the most part, you’ll end up paying more tax if you take more salary compared to dividends. But let’s explore the specifics in a bit more detail.

Navigating the UK Salary Allowances and Tax Brackets for Small Business Owners in 2023/2024

Small business owners need to understand the UK salary allowances and tax brackets in order to make informed decisions about their pay. Here’s what you need to know for the upcoming 2023/2024 year:

The current personal allowance for the 2023/24 tax year is £12,570. This means that you can earn up to £12,570 before you start paying income tax. Above this, you will fall into one of the 3 following bands: 

  • Basic rate tax band – £12,571 – £50,270. You’ll fall into the basic rate band and pay income tax at a rate of 20%.
  • Higher rate tax band – £50,270 – £125,140. You’ll fall into the higher rate band and pay income tax at a rate of 40%.
  • Additional rate tax band – £125,140+ and upwards. You’ll fall into the additional rate band and pay income tax at a rate of 45%.

It’s important to note that these tax rates apply to salaries, and different tax rates apply to dividends. As a small business owner, you may want to consider a mixture of salary and dividends in order to optimise your tax efficiency. 

To determine the best strategy for your business, it’s important to consult with a qualified accountant. If you’re in need of accounting services or advice, consider reaching out to Direct Peak Accountants today for a consultation. It’s important to plan early with a trusted partner, as you don’t want to be leaving money on the table!

What Are Dividends and How Do They Work for Small Business Owners?

You may have heard of dividends as a potential option for taking money out of your company. Dividends are payments made to company shareholders from the profits of the business. Here are some key points to understand about dividends:

  • Dividends differ from salaries in that they are not considered as earnings for tax and National Insurance purposes.
  • Dividends are taxed at a lower rate than a salary, helping to minimise the tax liability of the recipient.
  • Dividends can also be useful for managing personal income. They can be timed to suit the needs of the shareholder. If you have other income sources that push you into a higher tax bracket, you can take dividends at a date that suits you. Helping you to keep your income below the threshold for the higher rate of tax.
  • Additionally, dividends can be reinvested back into the business, which can help to promote growth and expansion.

The Benefits of Taking Dividends: How to Maximise Your Earnings

Dividends or Salary – The Case For Taking Dividends

Taking dividends instead of a salary can have several benefits for small business owners. Firstly, dividends are taxed at a lower rate than income tax, which can result in significant tax savings. In addition, taking dividends can help to manage personal income and reduce the impact of tax liabilities.

Another advantage of taking dividends is that they can help to improve cash flow. Unlike salaries, dividends do not have to be paid on a regular basis, which can give small business owners more flexibility in managing their finances. Additionally, dividend payments can be reinvested in the business, which can help to fund growth and expansion opportunities.

For small business owners who have a good understanding of their finances and can manage their cash flow effectively, taking dividends can be a smart choice. However, it is important to note that dividends are not guaranteed. A company must have sufficient profits to pay dividends to shareholders. Taking dividends may not be suitable for all business owners, which we will look into below. It is important to seek professional advice before making any decisions.

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The Drawbacks of Taking Dividends: Risks and Limitations to Consider

Dividends or Salary – The Case Against Taking Dividends

While there are benefits to taking dividends, it is important to understand the drawbacks before deciding to take them. One potential disadvantage is the fluctuation of income. Unlike a salary, dividends are not guaranteed and are dependent on the company’s profits. There may be times when dividends are not paid, which can make it difficult to plan for personal income.

Another potential drawback of taking dividends is the lower entitlement to state benefits. Dividends are not classed as earned income, so do not count towards entitlements such as the state pension, maternity pay, and statutory sick pay.

Finally, taking dividends can also be more complicated to manage than a salary. Dividends must be approved by the company’s board of directors and documented correctly to ensure compliance with tax regulations.

Understanding Current UK Dividend Allowances and Tax Brackets

Dividends or Salary – They Both Contribute To Your Tax Bracket!

As a small business owner, understanding the current UK dividend allowances and tax brackets is crucial to making informed decisions about how to pay yourself. Here’s what you need to know:

  • In the 2023/24 tax year, the dividend allowance is £1,000. This is less than it was the year prior, so pay attention!

Above this allowance, your dividends will be taxed at different rates depending on your overall income tax band, as per the thresholds set out in a prior section.

  • For basic rate taxpayers, the dividend tax rate is 8.75%.
  • For higher rate taxpayers, the dividend tax rate is 33.75%.
  • For additional rate taxpayers, the dividend tax rate is 39.35%.

Your dividend income will be added to your other taxable income when calculating which tax band you fall into. Additionally, taking a mixture of salary and dividends can provide additional flexibility in managing your tax liability. It’s easy to think that taking dividends is always the best way to approach it, but it can be more complicated than you may think.

But that’s where working on your taxes with a professional can be worth its weight in gold. At Direct Peak Accountants, we are across all applicable rules and regulations and can help you make informed decisions about your finances and ensure that you’re taking advantage of all available tax allowances. Don’t leave it to chance!

The Best of Both Worlds: Taking a Mixture of Salary and Dividends to Optimise Your Income

Dividends or Salary – A Balancing Act

Taking a mixture of salary and dividends can provide a balance between the benefits and drawbacks of each option. You may choose to take a basic salary to ensure you have a regular income and entitlement to state benefits. But you may also take dividends to reduce your overall tax liability.

This option can be particularly beneficial for small business owners who want to manage their personal income tax liability. By taking a salary, you can use your personal tax-free allowance, before taking dividends and reducing your overall tax liability.

It is important to note that taking a mixture of salary and dividends requires careful planning and consideration. We would recommended to seeking professional advice from an accountant or financial advisor before making any decisions.

Conclusion – Dividends or Salary? A Considered Mix Is Always Best

In conclusion, deciding whether to take a salary or dividends is a crucial decision for small business owners. You should carefully consider each option as they each have their own set of advantages and disadvantages that will factor into your decision.

  • Taking a salary offers benefits such as building up entitlement to state benefits and pension contributions.
  • Dividends offers benefits such as lower tax rates and improved cash flow.

However, both options also have their drawbacks, such as higher national insurance contributions and fluctuations in income respectively.

Ultimately, the best option for small business owners may be to take a mixture of salary and dividends. This can provide a balance between the benefits and drawbacks of each option.

At Direct Peak Accountants, we understand the complexities of managing finances for small businesses. Our team of professional accountants can provide expert advice on the best way to manage your finances and maximise your profits. Contact us today to learn more about our services and how we can help your business thrive.

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