We are often asked by business owners whether it is more tax effective to reward themselves by way of a bonus or dividend. The answer is almost always “It depends!” and in most cases, there will need to be some calculations done to look the tax impact of both options.
Historically, dividends have been a more tax efficient remuneration option than bonuses, particularly for those taxpayers with income in the higher and additional rate bands. However, the main rate of corporation tax is set to rise from 19% to 25% in April and the effective tax rates for bonuses versus dividends are expected to narrow.
Here’s a summary of the basic rules for the 2023/24 tax year:
Company bonus
- When an individual receives a bonus, income tax is payable in the UK at 20%, 40% or 45% for basic, higher and additional rate taxpayers respectively
- An individual will pay NICs at 12% for earnings between £12,570 and £50,270, and 2% thereafter
- Employers NICs are payable by the company, at 13.8% on earnings above £9,100
- The company is entitled to corporation tax relief on a bonus payment and the employers NICs thereon, which could save corporation tax at the small profits rate of 19% or at as much as 26.5% where profits fall in the marginal relief band
Dividends
- For UK resident individuals, a dividend is taxed at the dividend rates of income tax. There is a tax-free dividend allowance for 2023-24 of £1,000 (down from £2,000) and income tax is payable at 8.75%, 33.75% or 39.35% for basic, higher and additional rate taxpayers respectively
- The tax due is payable through self-assessment. For a dividend paid in the 2023-24 tax year, the tax would be payable by 31 January 2025
- Dividends are paid from a company’s post-tax profits and are not deducted in calculating the company’s profits subject to corporation tax. Therefore, paying a dividend does not reduce the corporation tax bill
How to decide whether a bonus or dividend is the most tax efficient?
The below table looks at the tax and National Insurance contributions that would be due on taking an additional £20,000 as either a dividend or salary/bonus for a basic rate tax payer, higher rate tax payer and finally an additional rate taxpayer. This does assume that an individual’s personal allowance and tax free band for dividends are already fully utilised.
| Basic Rate | Higher Rate | Additional Rate | ||||
| Dividend | Salary/ Bonus |
Dividend | Salary/ Bonus |
Dividend | Salary/ Bonus |
|
| £ | £ | £ | £ | £ | £ | |
| Profit | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 | 20,000 |
| Employer NIC | – 2,760 | – 2,760 | – 2,760 | |||
| Corporation Tax | – 5,000 | – 5,000 | – 5,000 | |||
| Cost to employer | – 5,000 | – 2,760 | – 5,000 | – 2,760 | – 5,000 | – 2,760 |
| Income tax | – 1,313 | – 3,448 | – 5,063 | – 6,896 | – 5,903 | – 7,758 |
| Employee NIC | – 2,069 | – 345 | – 345 | |||
| Cost to individual | – 1,313 | – 5,517 | – 5,063 | – 7,241 | – 5,903 | – 8,103 |
| Net | 13,687 | 11,723 | 9,937 | 9,999 | 9,097 | 9,137 |
| Effective tax rate | 31.57% | 41.39% | 50.32% | 50.01% | 54.52% | 54.32% |
This clearly illustrates that the effective rate of tax paid for both higher and additional rate taxpayers hardly differs between the salary/bonus route compared to taking a dividend.
In Summary
So to answer our question re. whether a bonus or dividend is more tax effective – for some companies, for the first time in a long time, it may be more tax efficient to pay a bonus rather than taking dividends.
There are of course other ways for owner managers to be recompensed, some examples may include benefits in kind or pension contributions, however, it is important for owner managed businesses to carry out detailed calculations to look at their individual circumstances.
It’s important to remember that tax is not the only driver behind the decision and that there are other considerations to consider.
If you need our help understanding how the how the corporation tax change could impact your business or you would like us to review your profit extraction strategy please get in touch.
