If you are a company director and shareholder of your own limited company, one of the most important financial decisions you make each year is how to pay yourself. The split between salary and dividends can save you thousands of pounds in tax — or cost you thousands if you get it wrong. This guide explains the most tax-efficient approach for the 2025/26 tax year, based on current HMRC rules.
The key principle: Salaries are subject to Income Tax and National Insurance (both employer’s and employee’s). Dividends are subject to Income Tax at lower rates but are paid from post-Corporation Tax profits. The optimal strategy balances these two to minimise your total tax bill.
Understanding the Tax Differences
Salary — How It’s Taxed
When you take a salary from your company:
- The company pays employer’s National Insurance at 15% on salary above £5,000 (the Secondary Threshold for 2025/26). Note: the Employment Allowance (£10,500) can offset this for eligible companies.
- You pay employee’s National Insurance at 8% on earnings between £12,570 and £50,270, and 2% above that
- You pay Income Tax at 20%, 40%, or 45% depending on your total income
- The salary is a deductible business expense for the company, reducing its Corporation Tax bill
Dividends — How They’re Taxed
When you take dividends:
- Dividends are paid from post-Corporation Tax profits (the company has already paid 25% Corporation Tax on the profits, or 19% for companies with profits under £50,000 via the Small Profits Rate)
- The first £500 of dividends is tax-free (the Dividend Allowance for 2025/26)
- Basic-rate taxpayers pay 8.75% on dividends
- Higher-rate taxpayers pay 33.75%
- Additional-rate taxpayers pay 39.35%
- There is no National Insurance on dividends — this is the main advantage
The Optimal Salary for 2025/26
For most owner-managed companies, the most tax-efficient salary is set at the employee’s NI Primary Threshold, which is £12,570 per year (equal to the Personal Allowance) for 2025/26.
At this level:
- You pay zero Income Tax (salary equals your Personal Allowance)
- You pay zero employee’s NI (salary is at or below the Primary Threshold)
- The company pays employer’s NI at 15% on the amount above £5,000, which is approximately £1,137. However, if the company qualifies for the Employment Allowance, this cost is eliminated entirely.
- The salary reduces the company’s Corporation Tax bill
For companies that qualify for the Employment Allowance (most single-director companies with other employees do, but sole-director companies generally do not), a slightly higher salary could be more efficient. The calculation is specific to your circumstances and worth reviewing with your accountant each year.
Taking the Rest as Dividends
After paying yourself the optimal salary, remaining profits can be extracted as dividends. The combined tax on dividends (Corporation Tax paid by the company, plus dividend tax paid by you) is typically lower than the combined tax on an equivalent salary.
Example: £50,000 Profit Before Salary
Consider a company with £50,000 profit before the director’s salary:
Option A: All salary (£50,000)
- Income Tax: approximately £7,486
- Employee’s NI: approximately £3,002
- Employer’s NI: approximately £6,750
- Total tax cost: approximately £17,238
Option B: £12,570 salary + £37,430 dividends
- Income Tax on salary: £0
- Employee’s NI on salary: £0
- Employer’s NI on salary: approximately £1,137 (or £0 with Employment Allowance)
- Corporation Tax on remaining profit: approximately £7,354 (at 19% Small Profits Rate on £38,707 after deducting salary and employer’s NI)
- Dividend tax on £37,430: first £500 tax-free, remainder at 8.75% = approximately £3,231
- Total tax cost: approximately £11,722
That is a saving of over £5,500 per year simply by structuring your pay correctly. The exact figures vary based on your total income, Corporation Tax rate, and personal circumstances, but the principle holds true for the vast majority of owner-managed companies.
Corporation Tax Considerations
For the 2025/26 financial year, Corporation Tax rates are:
- 19% (Small Profits Rate): For companies with profits up to £50,000
- 25% (Main Rate): For companies with profits over £250,000
- Marginal Relief: For profits between £50,000 and £250,000, with an effective rate between 19% and 25%
These thresholds are divided by the number of associated companies you control. If you have two companies, each threshold is halved (£25,000 and £125,000 respectively).
Important Considerations
- Pension contributions: Salary qualifies as pensionable earnings; dividends do not. If you want to maximise employer pension contributions, you may need a higher salary.
- Mortgage applications: Some lenders prefer salary income over dividends. Consider your plans before settling on a structure.
- State Pension qualification: You need to earn above the Lower Earnings Limit (£6,396 for 2025/26) to qualify for a year of State Pension credits. A salary of £12,570 comfortably covers this.
- IR35: If you work through your company but would be considered an employee if engaged directly, IR35 rules may apply and all income would be taxed as salary.
- Dividend documentation: You must hold a board meeting (even if informal) and issue dividend vouchers for every dividend payment. Without proper paperwork, HMRC can reclassify dividends as salary.
Get Your Tax Structure Right
The optimal salary-dividend split changes every year as tax rates and thresholds are updated. At HS Global Accountancy, we review our clients’ pay structures annually to ensure they are extracting profits in the most tax-efficient way. We provide company accounts and tax services for limited companies of all sizes, and our contractor services are designed specifically for owner-managed businesses.
Are You Paying Yourself in the Most Tax-Efficient Way?
We can review your current structure and show you exactly where the savings are.