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TAX TIP TUESDAY: Salary or Dividends. Which is Better for Tax Now?

Our 5-minute read – Tax Tips – for UK doctors and dentists will help you save tax, get organised with your tax affairs and make sure you meet important deadlines with ease.

This article does not constitute advice. Professional advice should be taken prior to acting on any part of it. The Financial Conduct Authority does not regulate tax advice. 

The choice is yours

As a contractor or the owner/director of a limited company, you have the ability to choose how you receive an income.

The first option is to simply receive it as a salary. The alternative is to actually cap your salary and collect the majority of your money in the form of dividends. But which scenario is better for taking advantage of valuable tax breaks?

Up until recently, the tax benefits associated with receiving the bulk of what you earn as dividends clearly outweighed the advantages of earning a salaried income. However, the recent changes to tax relief on dividends are prompting individuals to question if this is still the case.

The short answer is – yes, for many, the tax relief still leaves you in a better financial situation when you receive dividends. To understand why, let’s review the taxes you should be prepared to face.

Taking a salary

When considering how much to take in as a salary, be sure to keep your personal tax allowance in mind.

In the 2018/19 tax year, the allowance is £11,850, so anything above this threshold is treated as taxable income, subject to taxation at standard income tax rates. The table below shows these rates.

Band Taxable Income Rate
Basic Up to £34,500 20%
Higher £34,501 – £150,000 40%
Additional Over £150,000 45%

Keep in mind, if you make over £100,000, your allowance decreases by £1 for every £2 you earn and above £123,700, your allowance is £0.

Salaried income also diminishes for contractors after deducting 12% of your gross earnings for National Insurance Contributions on anything over £702 per month. But once your monthly income reaches £3,863, the percentage drops to 2%.

Between income tax and NIC contributions, it’s clearly advantageous to keep your salary on the lower end to save as much tax as possible and supplement with dividends.

Dividends for income

The first step to calculating an accurate profit for your limited company is to subtract business expenses, (salaries, insurance, accountancy bills, etc.) from your income. Once that is done, the profits get taxed at the corporation tax rate of 20%. The balance can then be distributed as dividends to the company’s shareholders.

When it comes to dividends, taxpayers are allowed a £2,000 tax-free dividend allowance. This reduced in the 2018/19 tax year from your previous dividend allowance of£5,000. Beyond your allowance, the tax rates on dividends function much the same as income tax in that there are three tiers.

Band Tax Rate
Basic 7.5%
Higher 32.5%
Additional 38.1%

Luckily, with dividends, there’s no need to worry about NI contributions. And tax rates are much lower, which leaves more of your money with you and not HMRC.

There’s no way around it – no matter how you choose to garner your income, you will pay tax. The key to paying less tax lies in the distribution of how you elect to receive your earnings.

An important decision like this shouldn’t be made alone, so seeking out experts to provide guidance is crucial.

At Dental & Medical Financial Services, we specialise in taking into account your tax affairs and reviewing your financial plans holistically. 

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