The impact of the dividend tax hike on remuneration planning

The Issue

Since the Budget many shareholders have been asking us whether the increase to dividend tax rates (an extra two per cent on the basic and higher rates from 6 April 2026) means that they should be looking at alternative profit extraction methods. The quick answer here is that it depends!

Broad analysis

The table below shows the marginal rates of tax that business owners will pay on their company profits, if they wish to extract them either as dividends or salary before and after the Budget.  These figures include any corporation tax payable (in the case of dividends) and employers and employees’ National Insurance (in the case of salary), but ignore the £500 tax-free dividend allowance.

The above analysis shows that basic rate taxpayers are better off extracting their profits as a dividend, but higher rate and additional rate taxpayers are better off taking a salary.

More detailed analysis

Before rushing to add yourself to the payroll, you need to appreciate that the analysis is more complicated than this.

Firstly, prior to these changes, it was always advisable for a company owner to pay themselves a salary up to the personal allowance (£12,570) because this obtains corporation tax relief with no income tax (plus, it also helps build up qualifying years for the state pension). Although some National Insurance would be payable, this still works out better than taking a dividend.  This advice remains sound.

Beyond the personal allowance the position is more nuanced.  You might think based on the above table that the logical conclusion is then to take a dividend at basic rates (plus the £500 tax-free allowance) and then take the rest of your income as salary.  However, the tax system does not work like this. Dividends are taxed as the highest slice of income. Therefore, the choice is either to take all the profits out as a dividend (to obtain the benefit of the lower basic rates) or to take everything as salary.

Because the marginal rates switch in favour of salary beyond the basic rate band, there ends up being a tipping point where the cost of suffering higher rates of tax in the basic rate band on salary is outweighed by the benefit of accessing lower rates further up the income scale.

We have crunched the numbers and determined that for a single shareholder with a trading company this tipping point comes in at around £345,000 of profits. Before the Budget, this tipping point was over £700,000.

Is there a better option?

A further comparison needs to be drawn with the rates of tax applied to sole traders and partners in partnerships (including LLPs).  For these “unincorporated” individuals the marginal tax rates are as follows:

You will see that being a sole trader or partner offers a better tax position at all profit levels. This option has become more favourable following the budget, due to the increase in dividend tax rates, while normal income tax rates remained untouched. A key point to bear in mind, though, is that choosing to operate in this way gives you no flexibility over when to take your profits because you pay tax on the full level of profits as they arise.

WSM’s view

The tax hikes applying to dividends are yet another attack on company owners, who the Government seems to see as a soft target. For most owner-managers, unless they are extracting significant amounts, taking a minimum salary and dividends will remain the preferred choice. However, for those extracting high levels of profit, a salary may now be the better option. For those who live completely hand-to-mouth, the LLP structure is looking ever more attractive – although it will usually not be viable to ‘disincorporate’ a company tax efficiently. There may be other considerations as well. For example, individuals above the state pension age are not liable to pay employees’ National Insurance, which makes a salary a significantly more attractive option. In addition, individuals who have personal assets used in the business (such as a property, or a director’s loan) may want to consider charging rent/interest, which makes the effective rate of tax even less.