If you’re a company director, you may think the most tax-efficient way to take money out of your company is through dividends. But as of 2022-23, and moving forward to the 2023-24 tax year, bonuses could be more tax-efficient.
We will cover:
- Legislation around paying tax on dividends
- Tax-efficiency between paying yourself dividends vs bonuses
Corporation tax on dividends received
Taxes on dividends and bonuses depend on an individual’s total income.
Limited companies have to pay their taxes and business expenses, like corporation tax (at 20%) and VAT, salaries, accounting, and insurance bills, before they give out dividend payments.
This means that the amount of profit left after paying expenses is the amount used for dividends.
Dividend recipients, like directors or shareholders, may have to pay taxes on the dividends they receive if the amount is over the dividend allowance.
They will pay this tax through their self-assessment tax return.
Companies do not pay taxes on the dividends they give out, but the recipients may have to pay taxes.
This makes dividends a tax-efficient option as recipients do not have to pay National Insurance contributions.
Tax-free dividend allowance vs bonuses
In the 2022 Autumn Statement the government announced sharp cuts to the dividend allowance.
It will be cut from £2,000 to £1,000 from April 2023, and then to £500 from April 2024.
The rate of dividend tax will remain the same.
In the past, dividends have been a more tax-friendly way to get paid compared to bonuses, especially for those who earn a lot.
But changes in tax rates are making the effective tax rates for dividends and bonuses about the same for all tax brackets.
For example, someone who earns over £125,140 in 2023/24 or over £150,000 in 2022/23 pays 51% tax on dividends and 55% tax on bonuses.
This difference will disappear starting April 6, 2023, when the tax rate for someone in this bracket becomes 55% for both dividends and bonuses.
Dividend tax bands vs bonuses
The change in profit extraction will make bonuses and dividends equal in terms of their effect on profits.
The amount of cash kept after a dividend payment will remain at 66.25%.
However, if a taxpayer is in a higher tax bracket, the amount of cash kept after a bonus payment will be:
- 65.7% if the profits are over £250,000
- 67.1% if they are between £50,000 and £250,000
Even if the Corporation Tax rate goes up, tax is not likely to be a big factor in deciding between bonuses and dividends because the results are so similar and depend on your specific situation.
Other things to consider:
- This analysis assumes that the person getting the bonus already earns £50,000. If they earn less, part of the bonus will be taxed at a higher rate.
- Dividends can only be given to shareholders and only in proportion to their ownership.
- Giving discretionary bonuses through dividends may cause tax problems.
- If an owner-manager plans to sell their business soon and doesn’t need cash, not taking a bonus or dividend may lead to a higher sale price taxed at a lower rate.
- However, if this results in a lot of extra money, it may affect tax reliefs that require the company to be “trading”.
Paying tax on dividends vs bonuses
The latest tax changes mean that in some cases, bonuses may now be more tax efficient than dividends.
For example, in 2023/24, if Mary earns a salary of £60,000 and receives dividends of £3,000, and her company is willing to give her £20,000 of profits either as a bonus or a dividend, Mary will keep more money if she receives a bonus instead of a dividend. The results are similar for people in higher tax brackets.
This is because bonuses can be claimed as an expense for tax purposes, whilst dividends cannot. So even though the company must pay National Insurance of £2,425 when paying Mary the remaining of the £20,000 (£17,575), a bonus won’t be liable to the 25% Corporation Tax, contrary to a dividend.
In this situation, the old idea that dividends are more tax efficient than bonuses no longer applies and each situation should be evaluated on its own.
High marginal tax rates and employer national insurance can be reduced by paying bonuses, which can also have non-tax benefits, such as making it easier to get a loan.
Additionally, bonuses can be a more targeted way of rewarding certain contributors.
Before making any decisions on remuneration strategies, speak to us. We can reduce your tax liability and maximise your income.
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