Many self-employed people are unaware that it may be more tax efficient for them to pay themselves using a combination of both salary and dividend payments rather than just via Pay As You Earn (PAYE).
The tax they pay on dividend income depends on the income tax band they fall into. For example, those on the basic rate will pay 7.5 per cent on dividends over their allowance. Meanwhile, those on the higher rate will pay 32.5 per cent and those on the additional rate will pay 38.1 per cent.
Anyone who is self-employed and owns their limited company can take money out as a dividend. However, this is only permissible if the company has made a profit and the dividends paid out are less than its available profits for current and previous financial years. Therefore, if the company has not made a profit but the individual still needs to pay themselves, they will need to do this via salary.
Everyone who owns a business gets a dividend allowance, which means they only pay tax on dividends over that amount. For the 2018-19 tax year, the dividend allowance was cut down to £2,000 from £5,000.
Individuals need to bear in mind that they might pay tax at more than one rate, depending on their overall dividend and non-dividend income. They also need to take their personal allowance into account, which is £11,850 for the 2018-19 tax year.
The tax situation varies depending on how much the individual earns as dividend income. The self-employed are likely to need to use their Self-Assessment tax return to do this. As all of this is quite complex, it might be a good idea to take professional advice before filling out any forms.