Dividends can be extremely confusing, but if you’re looking for the most tax-efficient way to extract money from a company, the pros often outweigh the cons. To help you get started, and figure out if dividends are the right option for you, we have put together a short guide with everything you need to know about tax and dividends in 2020/21.

What is a dividend?

A dividend is a share of a limited company’s profits. These are usually given to shareholders of the company and are generally considered to be the most tax-efficient way to take money out of the company.

Dividends can only be paid once the tax has been deducted from the profits, and they are also unable to be paid out if the dividends are worth more than the company’s profits from the previous or current year.

Who can dividends be paid to?

Dividends are normally paid to shareholders, and the percentage of the shares they own usually affects the number of dividends they are paid.

Shareholders are also sometimes employees of the company that they hold shares in. The most common form of this is when a person is a shareholder and the director of the company, and in this instance, the director will receive an annual salary as well as dividends.

How much tax will I pay when it comes to my dividends?

tax on dividends

The tax that you pay on your dividends will depend on your income and how much of that is from your dividends. If your dividends are within your Personal Allowance, then you wouldn’t have to pay any tax on your dividends as long as you aren’t receiving any other income. For most people, the tax threshold for personal allowance in 2020/21 is £12,500.

If you earn more than your allowance in dividends, there is also a tax-free allowance for dividends. For 2020/21, it is £2,000. If your dividend payment is worth more than both your Personal Allowance and your dividends allowance, you will be forced to pay tax on the part of your earnings that are above the threshold.

It is easy to calculate your tax band, you do this by adding your total dividends income to any other income that you receive. It is important to remember that you may need to pay tax at more than one rate. It may also be worth noting that dividends payments aren’t subject to National Insurance.

The dividends tax rate for 2020/21 dependent on how much tax you pay is as follows:

  • Personal Allowance – for those whose total income is between £0-£12,500 is 0% paid on dividends above the allowance.
  • Basic Rate Tax Payers – those whose total income is between £12,501-£50,000 is 7.5% paid on dividends above the allowance.
  • Higher Rate Tax Payers – those whose total income is between £50,0001-£150,000 is 32.5% paid on dividends above the allowance.
  • Additional Rate Tax Payers – those whose total income is £150,000+ is 38.1% paid on dividends above the allowance.

When and how do I pay dividends?

dividends and regulations

You can pay dividends as often as you like, but you need to remember to follow the regulations. Even if you are a director, every time you pay a dividends payment, you will need to have a directors meeting to declare the dividends.

It is also important to keep the minutes of the meeting. For every dividend’s payment, you will need to produce a dividends voucher with the date, company name, shareholders’ names, and the number of dividends being paid. A lot of companies decide to pay dividends quarterly, but some will choose to pay them annually or bi-annually.

Is it better to take a salary or pay myself in dividends?

If you are both a director and a shareholder of a limited company, the most efficient way of earning an income could be a combination of both a salary and dividends.

As a director, there is no threshold for minimum wage so you can pay yourself as much or as little as you please in terms of salary. If your salary is your sole source of income, then the most common method, and most effective, is to pay yourself a salary up to the threshold of National Insurance, and then pay the rest in dividends.

Are you unsure about how dividends work or whether you should take them? Maple Accountancy can help. We have a team of expert business advisors who can offer accountancy services, tax, and business advice for businesses in a range of sectors. To arrange a free no-obligation consultation contact us on 01332 207336 or success@maple.uk.com.