A continuing look into the dividend versus salary debate
Last week I continued my consideration of the dividend versus salary debate, with a look at three examples. I want to continue this week with three more.
Example 4: One-person company wanting to keep income under £100,000 personal allowance phasing out level: no employment allowance available.
Table 4.1 shows the dividend route absorbs more (£8,868.41) gross profit but this boosts the resulting net income by £14,207.82. The increase is proportionately less than in the £50,000 table 3.1 example (considered last week) because the extra £50,000 suffers 32.5 per cent dividend tax, after 19 per cent corporation tax (an effective marginal rate of 45.33 per cent).
This compares with £50,000 of salary where the corresponding rate, thanks to 2 per cent employee National Insurance contributions, is only slightly more at 49.03 per cent. In additional rate tax territory, the corresponding marginal rates are 49.86 per cent for dividend and 53.43 per cent for salary. If at least £3,336 of employment allowance were available, then, as in table 2.1 (considered last week), there would be a cut of £782.52 in the gross profit cost for the salary and dividend option, and a corresponding reduction in net benefit of £400.32 due to employee NICs.
Where there is no immediate director need for the available funds, then, assuming the constraints of the annual and lifetime allowances are not relevant, consideration should be given to a company contribution to a pension arrangement.
Just how effective this can be compared with a bonus or dividend is examined in the examples below.
Example 5: Higher rate taxpayer with £40,000 marginal gross profits to draw and no employment allowance available: bonus or dividend or pension?
If there is no dividend allowance available, then the net benefit from the dividend route falls to £21,870, only £1,483.36 more than the bonus route. The pension benefit is calculated as an uncrystallised fund pensions lump sum with a marginal tax rate of 30 per cent.
Example 6: Basic rate taxpayer with £10,000 marginal gross profits to draw and no employment allowance available: bonus or dividend or pension? If there is no dividend allowance available, the net benefit from the dividend route falls to £7,492.50, still £1,517.10 more than the bonus route because of the imp-act of 12 per cent employee’s NICs.
In conclusion, then: for money that is required immediately by the director and where a pension contribution is not possible or appropriate, the dividend route will always deliver the most favourable outcome. This will remain the case when the dividend allowance drops to £2,000 in the next tax year.
The saving in NI driven by the dividend is the key determinant. The reduction in corporation tax will also help companies with greater retained profits to pay greater dividends, especially when the rate drops to 17 per cent in the 2020 financial year.
Advisers have an important role to play in helping private company owner/manager clients to understand the changes and to organise their profit withdrawal strategies accordingly.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn