What is Salary vs Dividend?

Full Definition

Salary versus dividend is the central tax-planning decision facing an owner-director of their own limited company when deciding how to draw money out of the business, because the two routes are taxed very differently for both the company and the individual. A salary paid to a director is deductible against the company's profits for Corporation Tax purposes (reducing the tax the company pays at 19% to 25% depending on profit levels for 2026/27), but is subject to Income Tax under PAYE at the director's marginal rate (20%, 40% or 45% in England, Wales and Northern Ireland, or the equivalent Scottish bands) and to employee Class 1 National Insurance (8% between the primary threshold of £12,570 and the upper earnings limit of £50,270, then 2% above that), and the company must also pay employer secondary Class 1 National Insurance at 15% on salary above the £5,000 secondary threshold, though many small companies can offset some or all of this using the £10,500 Employment Allowance for 2026/27. A dividend, by contrast, is paid out of the company's post-tax profits and is not deductible for Corporation Tax purposes, but is taxed more lightly in the hands of the individual: the first £500 of dividend income in 2026/27 is covered by the tax-free dividend allowance, and dividend income above that is taxed at 10.75% (basic rate), 35.75% (higher rate) or 39.35% (additional rate) -- rates that remain meaningfully lower than the equivalent Income Tax rates on salary, and, crucially, dividends carry no National Insurance charge at all for either the individual or the company, which is the single biggest driver of the traditional tax advantage of dividends over salary for owner-directors. A very common strategy for owner-directors is therefore to draw a modest salary, often set at or around the National Insurance primary threshold (so it is free of employee and employer NI while still counting as a qualifying year for the State Pension and preserving the salary deduction against Corporation Tax), and to take the balance of profit extraction as dividends. The precise optimal split depends on the company's overall profit level, the director's other income, whether the £10,500 Employment Allowance is available (it is not available to companies where the director is the sole employee, a common restriction that catches many one-person contractor companies), and the interaction with the dividend allowance and Income Tax bands, so the calculation needs to be redone whenever rates or thresholds change, as they did significantly for dividend rates from April 2026. Worked example: a sole-director company with £60,000 of pre-tax profit could pay a £12,570 salary (deductible, no employee or employer NI at that level, and a qualifying year for state pension) and then extract further profit as dividends up to the higher-rate threshold, paying 10.75% dividend tax on amounts above the £500 allowance rather than the 40% Income Tax and NI that an equivalent amount of salary above the personal allowance would attract, though the company must still have sufficient distributable reserves and pay Corporation Tax on its profits before any dividend can lawfully be declared.

Related Calculators

See Also