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What are the benefits of paying dividends from my company?

Private limited companies make up about 37% of the total UK business population of 5.6m. More than half (56%) are sole trader businesses (ie self-employed people), while ordinary partnerships make up the remaining 7%. About 950,000 limited companies in the UK have no employees other than the sole director running the business (ie they are one-person-band companies).

Sole traders and members of ordinary partnerships pay themselves by withdrawing cash from their business. These amounts are called “drawings” and if they exceed the Personal Allowance (£12,570 in 2022/23), they’re subject to Income Tax and National Insurance contributions (NICs), which is calculated after the sole trader files a Self Assessment tax return each year.

How do limited company directors pay themselves?

Directors of small limited companies cannot pay themselves in the same way as sole traders. They can take money out of a company in several ways, but a common way for sole directors with no other employees is to:

  • pay just enough wages through the company payroll to not have to pay National Insurance contributions but qualify for state benefits.
  • with no Income Tax payable on their wages, because they do not exceed the Personal Allowance (£12,570 per year in 2022/23)
  • and the rest of their income is made up of company share dividend payments (which are subject to Income Tax over a threshold).

This can provide a small tax advantage, which means you pay less tax and take home more each month. Someone running a small limited company could just pay themselves a salary via the company payroll, with no dividends payments, but this option is less tax efficient.

Need to know! The income threshold after which people start paying National Insurance will rise to £12,570 in July 2022, a £3,000 a year increase, following the Chancellor’s Spring Statement in March 2022.

Who can benefit from dividend payments?

A dividend is a payment that a company makes to its shareholders. Share dividends are paid out of the company’s profits, whether from the current financial year or from profits retained in the company from previous financial years.

Dividends must be paid to all shareholders (ie everyone with company shares), not just a few or one (unless the company only has one shareholder). Many “one-person-band” limited companies have just one shareholder, who is the managing director of the company, so dividends are only paid to them.

What are the advantages of dividend payments?

The main advantage of receiving income from dividend payments when you’re the sole director of a limited company is that overall you pay slightly less tax, which means you take-home more.

In reality, the tax advantage can be relatively small, especially if you have to pay an accountant to administer your payroll and take care of the additional tax admin that goes with operating a limited company.

So, how much tax might you save? Well, if your business made a profit of £20,000, operating a limited company might deliver an overall tax saving of about £250, once Corporation Tax is also factored in. If your annual business profits were £40,000, your tax-saving could be as high as £1,000. So, the more profitable the company, the higher the overall tax saving.

This advantage was much more significant in previous years. For example, in the 2017/18 tax year, the dividend tax threshold was £5,000 a year, so you could take out £5,000 in company share dividend payments before having to pay tax (in the mid-2000s you take out £10,000 a year in tax-free dividends). The threshold has now been reduced to just £2,000 a year.

Find out more about the benefits of paying yourself dividends.

Higher tax on dividend payment in 2022/23

On 6 April 2022, the tax on dividend income will increase by 1.25 percentage points. The government says it will use the additional revenue to “support the NHS, health and social care”, following the additional financial pressures brought by COVID-19 in recent years.

  • If you’re a basic rate Income Tax payer, dividend payments over £2,000 in 2022/23 will be subject to 8.75% Income Tax (if your annual income exceeds the Personal Allowance).
  • If you’re a higher rate Income Tax payer, dividend payments over £2,000 will be subject to 33.75% Income Tax (if your annual income exceeds the Personal Allowance).
  • If you’re an additional rate Income Tax payer, dividend payments over £2,000 will be subject to 39.35% Income Tax (if your annual income exceeds the Personal Allowance).

The government says this 1.25 percentage point increase will be removed for the 2023/24 tax year, but from 6 April 2023, a new separate levy will be introduced to raise funds for the same purpose.

What are the risks with dividend payments?

Overpayment of dividends can leave a small limited company without enough cash to operate and pay its debts. Just because the company has, for example, £3,000 in profit in its bank account that month, it doesn’t mean it should be all paid out in dividends. Paying dividends of £2,000 and retaining £1,000 of profit within the company may be wiser and less risky.

Some months a company might not have enough profits in its bank account for dividend payments, whether as a result of cash flow issues (eg waiting for a client to pay a high-value invoice) or lack of sales. Dividend payments must be affordable and sustainable. Moreover, overpaying dividends can help to starve a small limited company of the cash it needs to grow.

You should know how much money you need to take home each month to cover your personal outgoings, and set a monthly dividend payment on that basis, also factoring in salary received via payroll. Before paying a higher dividend, sole company directors should work out how much the company can afford, taking into account operating costs and Corporation Tax liability. If you overpay dividends, there is also a risk that the company may not be able to pay its Corporation Tax bill.

When are dividend payments not a good idea?

Dividend payments can only be made from company profits, whether from that financial year or previous financial years if profits have been retained within the business. You should not and cannot pay dividends if the company is not making a profit.

Apart from being against the rules, paying out dividends that the company cannot afford is unsustainable and it can soon lead to serious cash flow problems or worse – it can kill a company.

And for companies with less predictable/uniform monthly revenue or sales or income, it can make dividend payments less predictable/uniform, which could also mean that dividend payments some months are not possible. This may cause professional and personal cash flow issues, which you may need to budget for or overcome.

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