One of the main financial benefits of being a Limited Company contractor is having the ability to choose how to pay yourself in the most tax efficient way. The most common way of doing so is by using a combination of dividends and salary, but how do you go about doing this?\r\n\r\nWhilst every contractor\u2019s needs are uniquely different - it\u2019s advisable to discuss your own personal requirements with a specialist contractor accountant - if you\u2019re just starting out and need a general overview, then this blog is for you.\r\n\r\nWhat is a dividend?\r\n\r\nA dividend is a distribution of company profits to its shareholders. Dividends are only payable if the company has the available profit to do so, and once business expenses, liabilities, tax (including Corporation Tax) and VAT have been paid. They also cannot be in place of payment for work or services. Limited Company contractors typically draw down the majority of their earnings in the form of dividends.\r\n\r\nWhen can you draw dividends?\r\n\r\nAs the director of your own Limited Company you are able to draw dividends monthly, quarterly or annually.\r\n\r\nIt\u2019s worth being aware that should you draw dividends on a regular basis this may be seen by HMRC as \u2018disguised salary\u2019 and could be subject to investigation. To reduce the risk you should minute your decision to take dividends and provide all shareholders with a dividend voucher. Taking these two steps will show an audit trail should you ever be investigated, plus they will be required for your annual tax return.\r\n\r\nWhat are the tax and National Insurance Contributions (NIC) implications?\r\n\r\nDividends don\u2019t incur any NIC, and this is why combining a low salary and high dividends is such a favourable way to pay yourself.\r\n\r\nThe dividends you draw yourself are taxed as personal income, with a tax-free allowance up to \u00a32,000 per person. with a tax-free allowance of currently \u00a32,000 (2020\/21):\r\n\r\nBasic rate (7.5%): up to \u00a350,000\r\n\r\nHigher rate (32.5%): between \u00a350,000 and \u00a3150,000\r\n\r\nAdditional tax rate (38.1%): \u00a3150,000+\r\n\r\nIt\u2019s also worth understanding that dividends are taxed on the date they\u2019re declared, rather than paid. For example, if you were to declare a dividend on April 1st but paid April 7th it would still be included in your tax return for the previous tax year, which could potentially take you over the basic or higher rate percentage.\r\n\r\nAlways double check with your specialist contractor accountant to make sure you\u2019re doing the right thing before taking any money out of the company, and what the tax implications will be.\r\n\r\nHow much should your salary be?\r\n\r\nYou are able to pay yourself whatever you wish! Salaries are classed as an allowable expense to your company, so you\u2019re entitled to tax relief, which ultimately lowers Corporation Tax bill.\r\n\r\nThe personal tax free allowance for 2020\/21 is \u00a312,500, but be aware that any amount over \u00a38,632 is subject to NIC deductions.\r\n\r\nIf it\u2019s just you in your Limited Company and there is no contract of employment, the National Minimum Wage Regulations do not apply. So affectively you\u2019re able to pay yourself \u00a38,632, which wouldn\u2019t be subject to any NIC deductions. So long as you pay yourself more than \u00a36,136 annually you\u2019ll still also be eligible for state pension contributions too.\r\n\r\nWhat are the limitations to a lower salary?\r\n\r\nBy paying yourself at the NIC threshold you could be missing out on a chunk of your personal tax free allowance, and other benefits you\u2019d only receive with a higher salary.\r\n\r\nFor example it could affect health and personal accident policies, as they\u2019re calculated in relation to your salary. It\u2019s also worth understanding that to qualify for maternity pay and benefits you must be \u2018employed\u2019 and paid accordingly within the National Minimum Wage Regulations, and therefore a lower wage would not satisfy these pre requisites.\r\n\r\nWhat could a combination of salary and dividends look like?\r\n\r\nThe following example looks at the breakdown between salary and dividends if a company owner paid themselves a salary of \u00a38,632 and dividend payments of \u00a360,000. Please note that there are many variables when it comes to tax such as tax codes and other incomes outside of the company, so ensure you speak to your contractor accountant for accurate figures which are correct to you:\r\n\r\nSalary: \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a38,632 (tax-free \u2013 personal allowance)\r\n\r\nDividends:\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a33,868 (tax-free \u2013 this is the remainder of your personal tax allowance up to \u00a312,500)\r\n\r\nDividends: \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a32,000 (the first \u00a32,000 is tax free \u2013 dividend tax allowance)\r\n\r\nDividends:\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a335,500 (\u00a337,500 basic tax band minus the \u00a32,000 dividend allowance) which is taxed at \u00a32,662.40 (7.5%)\r\n\r\nDividends:\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a318,632 \u2013 taxed at 32.5% as it\u2019s inside the higher tax band \u00a36,055.40\r\n\r\nTOTAL TAX PAID: \u00a32,662.50 + \u00a36,055.40 \u00a38,717.90\r\n\r\nTAKE HOME:\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a351,282.10\r\n\r\nWhen to seek advice\r\n\r\nTrying to figure out your combined contractor salary and dividends income can be confusing, and it\u2019s easy to make mistakes. That\u2019s why it\u2019s so important to enlist the services of a specialist contractor accountant who knows exactly what they\u2019re doing, and will help you take home the most from your contractor pay.\r\n\r\nGet in touch today to discuss your individual needs, and find out how SG can help you.