The relationship between personal and company earnings and how they interact can potentially cause a lot of problems for company directors.

As a director and shareholder of a limited company, you may receive a return on the shares you own. This is called a dividend, which is paid from the profits made by a company. Due to the potential tax advantages involved, paying a combination of a dividend, along with a small salary, could be the most tax-efficient way to take money out of a company.

Like other forms of personal income, a director receiving a dividend from a UK company will have to pay tax on that dividend if it is over the prescribed allowance for that year. The amount of tax a director pays on any dividend over that tax-free allowance is decided by the income tax band they are in.

Dividend allowance

In April 2016, a new tax-free dividend allowance was introduced to replace the old tax credit system. The dividend allowance is used to remove an element of double taxation, as dividends are paid on company profits which have already been subject to corporation tax.

Company directors can currently take £5,000 out of their company in dividends without paying any additional tax. Dividends over this amount are subject to a lower level of tax than other forms of personal income due to the 20 percent corporation tax which has already been paid. Dividend tax is then charged on drawings over £5,000 according to the company director’s income band at the rates you can see here.

As the director of a limited company, you are free to distribute dividends as often as you like as well as being able to determine the amount you distribute. However, the sum of the dividends distributed in your company year must not exceed the amount of profit your company has made. Any drawings over this amount will be classified as a director’s loan.

Personal allowance

Company directors, like every UK national, are also entitled to a tax-free personal allowance to set against their taxable income. The tax-free personal allowance is currently £11,000, which means company directors can take £16,000 out of their company, £11,000 as salary and £5,000 in dividends, before they pay tax. The UK tax-free personal allowance is subject to a £100,000 income limit. If income exceeds this limit an individual’s personal allowance is reduced

Taking dividends in the most tax efficient way

Many company directors choose to discuss the tax implications of different levels of drawings with a tax specialist to help them make the most of the tax allowances year-on-year. Many specialists suggest that company directors take dividends on a monthly or quarterly basis to make record keeping simple and keep dividend and salary payments separate to avoid any potential confusion.

Most important is to remember that any dividends company directors take will count towards the basic or higher rate income tax band, so you must think carefully to pay yourself in the most tax-efficient way.

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