Small Business Tax Optimisation

A general Disclaimer that:
Common wisdom seems to prefer Dividends over taking a Salary on the assumption that the overall tax burden is lower.
The idea is to take only enough Salary to qualify for National Insurance contributions or £12,570 (£13,704 gross incl ER NI).
An exhaustive analysis of the Dividend/Salary mix shows there is a cutoff point above which an Optimal strategy is to cap Dividends £50k gross (incl Company Tax) or £40,500.
As proof that this cutoff exists here is a comparison of the two methods for a fixed Revenue of £300k.
In this case the £50k Dividend strategy is £1,436 better off.

NI Salary

Maximising Dividends with an NI-only Salary

£50k Dividends

Capping Dividends at £50k gross (incl Company Tax) or £40,500

When reconciling against HMRC make sure to include the affect of Dividends on Personal Allowance as the Adjusted Net Income includes Dividends.
The Income tax Calculator is simplified and does NOT include entry for Dividends and hence does NOT reduce Personal Allowance appropriately when Dividends are present.
The Dividend Calculator is also a helpful resource.

Confusion about how the bands and PA work seems quite common, and I've noticed:
For 26/27 it is preferred to switch to the £50k Dividend strategy at just £189k of revenue.

Tax Increase

Relative to Optimal strategy

However the cutoff point has changed every year of the last 3 years: See bottom of the page for relevant tax parameters and their changes.
Intuitively one would expect a gradual transition between salary and dividends, however higher marginal rates cause a defined cutoff.
For Dividend taxes this is at the end of the Corporate tax small rate at £50k, above which a marginal rate of 26.5% is charged which drops to 25% at £250k.
For Salary taxes this is at the Employee NI rate of 8% at ~£13K which drops to 2% at ~£50k.
See bottom of the page for marginal tax rates.

At the limit, for both 25/26 and 26/27, the marginal Dividend tax is 54.51% vs Income tax of 53.91%, meaning once Salary is preferred it will always be so. See bottom of the page for cumulative tax rates.

Optimal strategy*

*Depending on your specific personal circumstances.
The optimal strategy seems to be:
  1. For the personal tax year, across all sources of income, earn a Salary until eligible for NI (Employee NI Primary threshold = £12,570)
  2. For the company tax year, withdraw Dividends until the Corporate tax Small rate (£50k of profits).
  3. Then: if expecting >£139k of Revenue per year, take as Salary, otherwise take as Dividends.
Step 3 requires either a prediction or holding cash in the company until the Revenue is known with a degree of certainty.
A misprediction results in a less than optimal outcome, however not unduly so see impact below.
'Revenue' in this context is net of Expenses and Pension contributions. Increasing Pension contributions would probably fit around Step 2 and/or Step 3.
As a company director, all 3 are calculated on an annual basis for the relevant tax year so little benefit in lump sumps.

Tax Increase from £50k Dividend Strategy

Taking only £40,500 Dividends (£50k gross incl Company Tax) rather than all Dividends above a NI Salary

For Revenues between £64k to £189k the £50k Dividend strategy can increase tax up to £3.7k (26/27).

Tax Increase from NI Strategy

Taking a salary of £12,570 (£13,704 gross) rather than following the £50k Dividend strategy

For Revenues over £189k the NI Salary strategy can increase marginal tax by 1.5%, falling to 0.6% above £264k (26/27).

Miscellaneous Findings

Tax Increase due to taking all as Salary

Rather than following the Optimal strategy

I believe this is effectively equivalent to moving from Outside IR35 to Inside IR35 (excluding Expenses & Pension)

Net Cost of £1 of Expenses or Pension Contributions

Assuming following the Optimal strategy

Equivalent Salary

Assuming following the Optimal strategy

How much additional you should ask for to move to Permanent Salaried Employment

Net value of moving £1 from Dividends to Salary

From Gross Dividends (incl Corp tax) to Gross Salary (incl ER NI)

Strategy if earning an additional Salary outside of the company

Cutover point between NI Salary Strategy and £50k Dividend Strategy

If earning a Salary outside your company, the cutover point above which the £50k Dividend Strategy is preferred drastically reduces.
For example, for 26/27 if earning an additional £30k the cutover moves from £189k to £119k, a £70k reduction.

NI Savings from payment in a Lump Sum

Paid in a 1 week Pay period rather than across the year

NI (ER&EE) is calculated not per year but per pay-period which is either weekly or monthly, implying a timing benefit could be achieved.
If one could, taking £12,570 in one weekly pay period would increase NI ER by £736 and NI EE by £290, a total loss of £1,026.
However due to the company director rules, NI calculations are annualised.

Reference

Tax Parameters & Changes

24/25 25/26 26/27
Personal Allowance 12,570 12,570 12,570
Personal Allowance Limit 100,000 100,000 100,000
Dividend Allowance 500 500 500
Savings Startingrate 5,000 5,000 5,000
Savings Allowances 1 1,000 1,000 1,000
Savings Allowances 2 500 500 500
Savings Allowances 3 0% 0% 0%
Capgains Allowance 3,000 3,000 3,000
Income Bands 1 37,700 37,700 37,700
Income Bands 2 125,140 125,140 125,140
Income Rates 1 20% 20% 20%
Income Rates 2 40% 40% 40%
Income Rates 3 45% 45% 45%
Dividend Rates 1 8.75% 8.75% 10.75% (2%)
Dividend Rates 2 33.75% 33.75% 35.75% (2%)
Dividend Rates 3 39.35% 39.35% 39.35%
Capgains Rates 1 13.46% 18% (4.54%) 18%
Capgains Rates 2 21.73% 24% (2.27%) 24%
Capgains Rates 3 21.73% 24% (2.27%) 24%
NI Primary Threshold 12,570 12,570 12,570
NI Upper Limit 50,270 50,270 50,270
NI Main Rate 8% 8% 8%
NI Upper Rate 2% 2% 2%
Employer NI Threshold 9,096 5,004 (-4,092) 5,004
Employer NI Rate 13.80% 15% (1.20%) 15%
CT Small Rate 19% 19% 19%
CT Main Rate 25% 25% 25%
CT Lower 50,000 50,000 50,000
CT Upper 250,000 250,000 250,000
Tax Type Who Pays Calculation Frequency Payment Frequency Tax Year / Accounting Period Reporting Requirement
Income Tax Employee (withheld by employer) & Self Assessment Annual, but approximated and withheld at payroll run Employer remits monthly (or quarterly for eligible small employers) UK tax year: 6 April – 5 April Reported to HMRC via Real Time Information (RTI) on or before each payroll payment
Employee National Insurance (Employee NI) Employee (withheld by employer) Each payroll run (weekly, monthly, etc.)
Employer National Insurance (Employer NI) Employer
Corporation Tax Company Each accounting period (typically annual) Usually due 9 months and 1 day after the end of the accounting period; large companies may pay quarterly instalments Company accounting period (not tied to the UK tax year). Usually when incorporated. Corporation Tax Return (CT600) due within 12 months of the accounting period end
*Table generated mostly by LLMs

Marginal Income Tax

Marginal Dividend Tax

Marginal & Cumulative Taxes

Personal Taxes

Cumulative Taxes

Those earning a Salary and even those earning Interest generally pay thousands of pounds more than those receiving Dividends.

Marginal Taxes

At £50,270+1 and £125,140+1 the sudden withdrawal of the Personal Savings Allowance causes a £100 increase in taxes.
This increase would require additional savings of £167 and £182 respectively just to break even (100/(1-0.4) & 100/(1-0.45)).

Annual Allowance

Annual Allowance (AA) is the limit on pension contributions before incurring AA charges.

Graph shows current-year AA. Exceeding the shaded region consumes carry forward AA (up to 3 yrs) or incurs AA charges at marginal income tax rates.

One would assume that only incomes over 260k are affected, however as Employer contributions are added to "Adjusted income" the AA tapering starts at just 200k of income.

An important feature is the Employer contribution itself reduces AA so while the formula implies a gradient of -1/2 it's actually -1/3. Given the AA tapering is 50k (60k less 10k), this gives a 150k range from 200k to 350k where this applies.


Threshold limit

The Threshold limit would seem irrelevant as Adjusted Income Limit (260k) less AA (60k) is the Threshold (200k). However, it is the escape hatch for contributing carry forward without reducing this year's AA. Once income >200k the contributions intended for carry forward reduce this year's AA, which either consumes even more carry forward or incurs AA charges.

Above the Threshold

If you're already over the Threshold should you avoid contributing more than 60k? Not necessarily if you have carry forward available and particularly if some of it would expire.

There are also probably some circumstances where incurring AA charge at marginal income rates actually makes sense. For example, to quarantine future investment gains despite no contribution benefits. Probably when close to the age or circumstances where withdrawal starts to be possible.

Notes / References

Disclaimer

In addition to a general Disclaimer that: I've attempted to list what some additional factors could be: Not relevant to choosing the Dividend/Salary split are some of these factors:

About

For questions or comments please email the alias reedjoseph707 at gmail.