What are Dividends?
It might seem like an obvious question but let’s take a look at what dividends are, how you take them and what tax you might pay in doing so.
The dictionary definition is ‘Dividends are a sum of money paid by a company to its shareholders out of its profits or reserves’.
You may be thinking; how will I know how much I have in profit or reserves? This is where our financial report informs you on a regular basis how much is available by providing the maximum figure that can be withdrawn from the company without going ‘overdrawn’ (which left unchecked could result in paying taxes of 32.5% on the overdrawn amount).
It may sound obvious, but the company needs to have made a profit (at some point) in order to take dividends. Dividends are a result of a surplus in the company and this surplus is only usually available if profit has been made through trading.
The exception to this would be if the company had made a profit in previous years and then had a loss year, where dividends could still be drawn due to the retained profit held within the company.
How much is Dividend tax?
Dividends are tax free up to the level of the dividend tax allowance, with 7.5% paid within the basic tax band, 32.5% in the higher rate tax band and 38.1% in the additional rate band.
Dividend Tax Allowance
In April 2016 the dividend tax free allowance amount was £5,000 per person, though this has since dropped to £2,000 for 2018-2019.
Am I better off taking Dividends?
The dividend tax was brought to bring the taxation of dividends more in line with the taxation of sole traders and self-employed.
In addition to income tax, sole traders pay Class 4 NI on any profits over the secondary threshold at a rate of 9%, so paying dividend tax in the basic rate band at 7.5% is still more tax efficient.
Directors of limited companies also have the freedom of choice over what dividend amount to draw from their companies (and therefore the amount of tax that will be paid based on the dividends taken), whereas sole traders have no dividend tax allowance, pay tax on all their profit, whether the funds are physically drawn from the business or not and pay 9% in Class 4 NI over the secondary threshold (which is £8,424 in 2018-2019).
How do I know how much to take and how much tax I will pay?
The calculation of dividends available and dividend tax is always stated in your financial report, so you will always know how much tax you need to put away, as long as the accounting information is provided at regular intervals.
What’s the best way to take dividends?
There is no ‘right or wrong’ way to take dividends, except to ensure there is enough money in the company to take them out. Once this has been established, you can draw the amounts from the company, by declaring the dividend, monthly, quarterly or annually, then transferring the amount to your personal bank account from your business account marked ‘Dividends’
What’s the bottom line?
We suggest taking dividends only when it has been confirmed the amount that is available, in order to prevent your company going overdrawn. It is also wise to leave a small amount of retained profit within the company to allow for any financial fluctuations, a period of trading loss, or end of year accounting adjustments.