A Contractors Guide to Salary Dividends (Up to date for 19/20 tax year)
Our guide to Contractors Salary and Dividends: How much you can take home and how to take it.Mon, 25 Nov 2019
A contractor’s guide to salary and dividends
This Guide was written by Patrick Gribben, contractor and freelancer Tax Expert at Intouch Accounting. Patrick now writes for Listentotaxman.com on matters relating to contractor and freelancer tax. He and his colleagues are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Intouch Accounting website for contact details.
Whether you’re already contracting or you’re considering going self-employed on a full-time basis, there’s a lot to know when it comes to paying yourself as a Limited Company contractor. How much money you take and how you take it should be carefully considered, as tax and National Insurance Contributions (NIC) work differently to how PAYE salaries work.
In this guide, we’ll be covering everything from what pay options you have, what the tax implications are, and how to decide what’s best for you. You may have heard of combining salary with dividends, but what does this actually mean?
Salary - A regular, fixed payment for services. Typically paid from an employer to an employee.
Dividend - Payments made to the owner or any shareholder in the business. This payment comes from the business’s profits after corporation tax has been deducted and is not a payment for services.
Combining salary with dividends - the basic rules
As the director of your own Limited Company, that makes you both an employee and a shareholder of the business, which gives you the added benefit of being able to pay yourself in both salary and dividends.
To put it simply, a Limited Company contractor can minimise their tax bill and NIC by paying themselves a low salary and then taking the rest of their payment in dividends. Every contractor’s circumstances are different, so there’s by no means a ‘one size fits all’ approach, but in understanding the different tax thresholds and personal allowances, this will help you come to a decision that feels right for you.
What salary level is appropriate?
As the director of your own Limited Company it is entirely down to you how much you pay yourself. However, many choose to pay themselves a basic salary up to the NIC threshold which for the tax year 2019/20 is £8,632.
While you won’t pay any NIC on a salary of up to £8,632, you will be missing out on a chunk of your personal allowance.Your personal allowance for 2019/20 is £12,500, and this is the amount you can receive in salary before seeing any income tax deductions.
What National Insurance Contributions will I have to pay?
As the director of your company you will be subject to Class 1 NIC, which is paid at a rate of 13.8% (Employers NI) and 12% (Employees NI) of the gross salary above the threshold of £8,632. So this is where you can start to play around with the amount you pay yourself in salary and dividends to find a balance that makes your business as efficient as possible when it comes to tax and NIC.
If you have more than one employee in the company, you would be entitled to claiming employment allowance, which means you wouldn’t pay employers NI above the £8,632 threshold to HMRC up to the value of £3,000.
Can I choose not to pay myself a salary?
While a benefit of being the director of your own Limited Company is you do not need to comply to the National Minimum Wage regulations when paying yourself, it is recommended that you pay yourself at least at the NIC threshold for a number of reasons.
Drawing a £NIL salary would mean you do not pay any NIC contributions but this has its drawbacks such as:
- Reduces or removes your entitlement for state pension
- Lose entitlement to maternity benefits
- Can affect insurance policies such as medical and personal accident cover
How much can I pay out in dividends?
The amount you decide to pay yourself in dividends depends on what profits are available, and you’ll also want to factor in tax on dividends. The breakdown below works on the basis of your combined income from salary and dividends:
- Up to £2,000, plus any unused Personal Allowance: tax free
- Up to £50,000: taxed at 7.5%
- Up to £150,000: Taxed at 32.5%
- £150,000+: Taxed at 38.1%
While you do have to pay tax on dividends, you don’t have to pay NIC. To keep your tax bill low, you may wish to only draw out up to the lowest tax threshold which is £50,000. You can carry over profit each year and allow it to grow, so don’t feel like you have to declare dividends before the company’s year end.
So for example, if you made a profit of £20,000 in year one, but didn’t pay out any dividends, you could carry that over to the following year. If you then made a further £30,000 in year 2 and then decide you wish to declare a dividend, you could take a total of up to £50,000 of combined income from salary and dividends within the basic rate threshold.
Ensure you are aware of the amount of Corporation Tax to be paid and that there are enough profits to cover it, otherwise this could be seen as an illegal dividend. If a dividend is declared and then found illegal, there are of course consequences and the director and shareholders could be found personally liable. If money is then owed, HMRC may also then class this as a loan, which could then be subject to tax of 32.5% of the total amount repayable.
How and when can I declare a dividend?
The director/s (you), will decide how much dividend is to be paid on each share. You can declare a dividend at any time, but the time it is paid can be very important depending on which tax year it falls into. A dividend should be declared at a time to suit all shareholders and they must receive a receipt or voucher which will be used for completing their tax return.
As we said, there is no one perfect combination of salary and dividends, and every Limited Company will be different. Factors such as whether you’re the sole employee of your business or whether you and your partner both hold shares in the business will determine how you decide to distribute dividends. Speaking to a good contractor accountant will help you find the best option for you.
What about dividends when I’m inside IR35?
If a contract is found inside IR35 then you cannot use the more favourable low salary plus dividends payment option for the duration of that contract. While you are working on that contract, all payments must be made via salary.
SummaryWhile there isn’t a salary and dividends combination that will suit every contractor’s needs exactly, it is very common for contractors to opt for the modest salary, high dividend combination. However, your own personal circumstances will affect the way in which you choose to pay yourself, such as whether you are a one-person business or if you have employees/family members working for you, whether you have any other streams of income from outside your business, IR35 risks and how long you intend to contract for.
With all of these factors and more in mind, we always recommend speaking to a professional contractor accountant who can talk you through the options and help you come to the most tax-efficient decision for you.
This Guide was written by Patrick Gribben, Tax Expert for contractors and freelancers at Intouch Accounting. Patrick now writes for Listentotaxman.com on matters relating to contractor and freelancer tax. He and his colleagues are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Intouch Accounting website for contact details.</div