Dividend Tax for Company Directors, Salary Plus Dividends

The Typical Director Structure

Most sole-director limited company owners take a low salary, typically around £5,000 to £12,570, and draw the remainder of their income as dividends from post-corporation-tax profits. This structure exists for two reasons: first, dividends are not subject to National Insurance (either employee or employer), whereas salary attracts employee NI at 8% (up to £50,270) and employer NI at 15%; second, dividend tax rates are lower than income tax rates on salary at the same income level.

A salary of £9,100 (just above the NI lower earnings limit, qualifying for a State Pension credit year) means the company pays no employer NI and the director pays no employee NI on the salary. A salary of £12,570 (the personal allowance) eliminates income tax on the salary but does attract employer NI on the portion above the secondary threshold of approximately £5,000. Whether £9,100 or £12,570 is optimal depends on the corporation tax rate and whether the employer NI cost is worthwhile for the additional personal allowance saving.

Calculating the Effective Rate, Worked Example

Consider a director with a £9,100 salary and £50,000 in dividends, total income £59,100. Income tax on salary: the £9,100 salary is entirely within the personal allowance (£12,570), so nil income tax on salary. Employee NI on salary: nil (below the primary threshold). Employer NI: nil (below the secondary threshold of approximately £5,000, actually £9,100 is slightly above £5,000, so employer NI applies on the excess of approximately £4,100 at 15% = £615 paid by the company).

On the £50,000 of dividends: personal allowance is £12,570, of which £9,100 is used by salary, leaving £3,470 of personal allowance available for dividends. The first £3,470 of dividends is sheltered by the remaining personal allowance (nil tax). The next £500 is the dividend allowance (nil tax). Dividends now assessed: £50,000 − £3,470 − £500 = £46,030. The remaining basic-rate band is £50,270 − £9,100 = £41,170. Of the £46,030 taxable dividends, £41,170 falls in the basic-rate band at 8.75% = £3,602; the remaining £4,860 falls into the higher-rate band at 33.75% = £1,640. Total dividend tax: approximately £5,242. The director's effective personal tax rate on £59,100 total income is approximately 8.9%.

The Dividend Allowance Within the Structure

The £500 dividend allowance is factored into the calculation above, it sits within the basic-rate band after the personal allowance is used by salary. For a director with a low salary, the personal allowance shelters considerably more income than the dividend allowance, making the dividend allowance a relatively minor component of the overall saving. Its main value is for directors whose salary already uses the full personal allowance, where the £500 allowance provides a small additional exempt amount at the bottom of the dividend assessment.

When the Structure Stops Being Tax-Efficient

Above total income of £50,270, dividends start attracting 33.75%, the higher-rate dividend tax. For a director taking a £9,100 salary, dividends are taxed at 8.75% up to total income of approximately £50,270, and at 33.75% above that. The structure remains more tax-efficient than equivalent salary income above £50,270 (where salary would attract 40% income tax and 2% NI), but the advantage narrows significantly.

Above £125,140, dividends are taxed at the additional rate of 39.35%. At this point, directors with very high incomes may benefit from reviewing the corporation tax position more carefully, particularly if profits are being retained in the company rather than extracted, which can trigger complex rules around close companies. Taking large employer pension contributions directly from the company is often more efficient than dividends above the higher-rate threshold.