Salary or Dividends for tax efficiency when on higher rate?

[Willapp]

Hi,

I realise the stock answer here is "ask your accountant" which I have, but he's a little slow responding and I wanted to get some other opinions anyway. Situation: I have just started contracting again having been in a perm role since the start of this tax year. To date I've already earned around £40k paid as salary.

I think the ideal situation would be that I don't take any money from my contract role until April when I can start taking the minimum salary and the rest as dividends as I used to do when contracting previously. However most of my savings are tied up and I'd get penalised for withdrawing so one way or another I'll need to take a few £k's from my business to cover bills etc for the next 3 months.

So the question is, do I get my accountant to set me up on payroll and start taking a salary straight away - and if so what salary? Or do I not take a salary and take it from dividends instead? I am a little unsure of which option is best from a tax perspective (both my personal liability and that of the business) or does it work out the same? Let's say I needed to take £3k a month for the next 3 months, how do the figures stack up?

Cheers,
Will.

[Craig at Nixon Williams]

Hi,

I realise the stock answer here is "ask your accountant" which I have, but he's a little slow responding and I wanted to get some other opinions anyway. Situation: I have just started contracting again having been in a perm role since the start of this tax year. To date I've already earned around £40k paid as salary.

I think the ideal situation would be that I don't take any money from my contract role until April when I can start taking the minimum salary and the rest as dividends as I used to do when contracting previously. However most of my savings are tied up and I'd get penalised for withdrawing so one way or another I'll need to take a few £k's from my business to cover bills etc for the next 3 months.

So the question is, do I get my accountant to set me up on payroll and start taking a salary straight away - and if so what salary? Or do I not take a salary and take it from dividends instead? I am a little unsure of which option is best from a tax perspective (both my personal liability and that of the business) or does it work out the same? Let's say I needed to take £3k a month for the next 3 months, how do the figures stack up?

Cheers,
Will.

Assuming that you are, or are very close to being a HR tax payer, you would be far better taking dividends than salary. On the salary you will pay 40% tax plus 12% NI, whereas on the dividends you will pay 25% tax. The salary would be deductible for CT, but this saving would not outweigh the tax and NI on the salary so you are better sticking with dividends.

[Andrew@Wisteria]

Hi,

I realise the stock answer here is "ask your accountant" which I have, but he's a little slow responding and I wanted to get some other opinions anyway. Situation: I have just started contracting again having been in a perm role since the start of this tax year. To date I've already earned around £40k paid as salary.

I think the ideal situation would be that I don't take any money from my contract role until April when I can start taking the minimum salary and the rest as dividends as I used to do when contracting previously. However most of my savings are tied up and I'd get penalised for withdrawing so one way or another I'll need to take a few £k's from my business to cover bills etc for the next 3 months.

So the question is, do I get my accountant to set me up on payroll and start taking a salary straight away - and if so what salary? Or do I not take a salary and take it from dividends instead? I am a little unsure of which option is best from a tax perspective (both my personal liability and that of the business) or does it work out the same? Let's say I needed to take £3k a month for the next 3 months, how do the figures stack up?

Cheers,
Will.

In fairness to your accountant, January is quite a busy period, although anything more than 2 days is in my book is bordering unacceptable - a holding response in that period is at least better!

If you draw further salary, up to £41,865 you will get charged 20% tax and 12% NI (32%). After that 40% tax and 2% NI (42%). But the company receives a 20% deduction against the salary.

If you draw as dividends, up to £41,865 is tax free (net dividends would be £1,678.50 being £1865*0.9) After that you would pay 25% personal tax on any further dividends drawn (because you drop into the higher rate tax bracket. E.g. You would need to draw £12k in order to get your £9k (assuming the basic rate tax band has already been used up by your income for 2014/15).

The overall effect is that the higher rate dividends are charged at 32.5% tax after taking into account the tax credit, plus they have no NICs on them.

[barrydidit]

Would you be able to utilise your directors loan account for the next few months, and then repay from dividends declared in April?

[Contreras]

Consider taking a loan from YourCo, to be paid off in the new tax year but before your company year end. Will be >£10k so needs documented shareholder approval and you need to pay YourCo interest on the loan at HMRC official rate in order to prevent it being a BiK.

https://www.gov.uk/directors-loans/y...-company-money

Obviously, in addition extract all possible tax free expenses as you can.

[sal]

As others suggested taking the 3x3k as a director loan from YourCo and repaying them in April once you can draw dividends in the new financial year is your best bet. Just keep in mind that this will impact your finances in the next year as you would have eaten 9k out of the 41k odd threshold for the new year leaving you with 32k for the next 12 months potentially in need to take on loan again before the end of the next year.

[Maslins]

I'd personally avoid the director loan ideas suggested above, unless you're confident that even with the additional dividends from that next year, you'd still likely fall below higher rate threshold.

Otherwise you're not saving any tax, just kicking it along the road whilst simultaneously creating extra complications and risk you get in a mess, spend the cash, then struggle to play catch up further down the line. Seen this happen many many times to people who think they're being smart.

My advice would be take the dividend (as that will be more tax efficient than salary). Yes this will push you into higher rates, but you may well find you get a tax rebate (or have only a very modest tax liability) due to the PAYE suffered on employment earlier in the year.

[TheCyclingProgrammer]

I was going to suggest the directors loan approach too but Maslins makes a good point. If you can't get by on what's left of your basic rate band after paying off the loan, you'll only be in the same position again next year. But it might still be a useful option if you can make the £32k remaining work for the rest of the year.

At the higher rate, the main saving is in NIC as thhe effective tax rate on the higher rate dividend is 40% once you account for the corporation tax on your gross profit, e.g. £8k of net profit taken as a dividend would be after £2k CT and there will be a further £2k of income tax due.

[northernladuk]

I'd personally avoid the director loan ideas suggested above, unless you're confident that even with the additional dividends from that next year, you'd still likely fall below higher rate threshold.

Otherwise you're not saving any tax, just kicking it along the road whilst simultaneously creating extra complications and risk you get in a mess, spend the cash, then struggle to play catch up further down the line. Seen this happen many many times to people who think they're being smart.

My advice would be take the dividend (as that will be more tax efficient than salary). Yes this will push you into higher rates, but you may well find you get a tax rebate (or have only a very modest tax liability) due to the PAYE suffered on employment earlier in the year.

^ This...

Don't let the tax tail wag the dog IMO. The tax thresholds are not there to punish us or cause us stress and complications. Sometimes you go over and pay a bit more, sometimes you don't. We aren't talking life changing amounts here so do the best you can to stay under, if you don't, pay the bit extra and carry on but make note to not do it again.

[Willapp]

Hi all,

Thanks for the advice. I'm certainly not trying to avoid paying any tax and I agree with the later comments regarding the Directors Loan idea, so I don't think that's the right choice in this situation. However it seems fairly unanimous that a dividend is better than salary so assuming my accountant is in agreement, that's what I'll do.

Cheers,
Will.