Many contractors, freelancers, and self-employed individuals opt to operate through a limited company. This business structure offers numerous benefits, including flexibility in remuneration and significant tax advantages.
A tax-efficient remuneration strategy involves structuring income to minimize tax liability while ensuring compliance. Utilizing dividends and understanding the dividend allowance is crucial in this regard.
Self-employed individuals operating through a limited company should ensure they grasp the concept of dividends, including the dividend allowance, to optimize their earnings.
Dividends Explained
Dividends represent the profits of a limited company distributed among directors and shareholders after the payment of corporation tax. They serve as a source of income and a reward for their investment in the business.
Understanding the Dividend Allowance
The dividend allowance allows for a certain portion of dividends to be untaxed annually. For the tax year 2023/24, the dividend allowance stands at £1,000. This allowance remains unaffected by other sources of income.
You can receive tax-free dividend payments within the personal allowance limit, which is £12,570 for the tax year 2023/24. Consequently, you can earn a maximum of £13,570 in untaxed income.
Unfortunately, HMRC has reduced the dividend allowance in recent budgets. In the tax year 2024/25, it will halve again to £500.
How Dividend Payments
Work Shareholders in a limited company receive dividend payments based on their shareholdings. For sole shareholder contractors, all dividends paid after tax belong to them. However, if there are multiple shareholders, dividends may be divided accordingly.
Dividend payments cannot exceed the available retained profits from the current or previous financial year. Before issuing dividends, a directors’ meeting must be held to declare them, and minutes of the meeting must be kept.
Taxation of Dividends
Dividends above the dividend allowance are subject to tax, but they are taxed at lower rates compared to salary income. Unlike salary, dividends are not subject to National Insurance contributions. Only the individual receiving dividends is taxed, not the company issuing them.
The rate of dividend tax depends on the amount of dividends received and total income during the tax year. Dividends are typically taxed as the top slice of income after considering other sources of income.
Drawing Dividends
Dividends should only be withdrawn when there are sufficient retained profits in the business. They can be withdrawn at any time, although quarterly or monthly withdrawals are common.
Drawing dividends without adequate retained profits can be considered illegal or a director’s loan, which must be repaid and may attract HMRC scrutiny.
Determining Dividend Amounts
To calculate the amount of dividends you can draw, establish your retained profit (net profit) by deducting expenses from income. This net profit, after deduction of corporation tax, combined with any accumulated retained profits from previous periods, determines the maximum dividend that can be declared.
You’re not obligated to draw out all retained profits as dividends; they can be reinvested in the business for growth or financial stability.
Partnering with Neon Accounting
When you engage Neon Accounting, you benefit from support in setting up leading Xero accounting software and fixed monthly fees. Xero offers comprehensive automation features for tax returns and bank transaction reconciliation, facilitating better financial management.
Neon Accounting provides expert management of your business and personal accounts, with unlimited support and timely responses to your queries, ensuring smooth financial operations.