Dividends or bonuses? We can work it out!

Peter Rayney examines an owner-manager’s cash extraction following the numerous tax and National Insurance contributions changes.

On a wintry sunny morning, Alan was reviewing his company’s January 2024 management accounts. Alan was the sole director and 100% shareholder of Llandudno Hotels Ltd, which operated two large hotels in Llandudno. The business was on course to healthy pre-tax profit of around £650,000 for the year ended 31 March 2024. Alan had been planning to pay himself a substantial ‘bonus’ before the year-end.

However, following the recent tax and National Insurance contributions (NICs) changes, he was now a little perplexed and did not know whether it was best to pay himself a dividend or a bonus. As always in times like these, he decided to ring his trusted accountant, Suzanne.

“Hi Suz (Alan always called her that!), as I told you last week, we are having a really good year and I want to take a sizeable payment out of the company – it’s the first time in years since I have been able to do so. We always took ‘my money’ out as a dividend. But with all the recent tax and NICs changes, I really don’t know whether it’s still the right thing to do. I find it all very confusing. What would you recommend?”

Suzanne replied: “Yes – things are not the same anymore – and as a general rule, dividends are not as beneficial as they used to be. The decision to pay a dividend over a bonus really depends on your individual circumstances. The best thing here, Alan, is for me to run some numbers on a spreadsheet for you and see what this tells us.”

“That’s a great idea”, answered Alan. “As you know – the company now has quite a bit of cash in the bank – about £400,000 – which we have built up over the last few years. I think I could safely take out, say, £100,000 – which would still leave a respectable buffer and support our trading cash flows. How much would the tax be on that? If you could let me know whether I should take it as a dividend or a bonus. By the way, just to let you know, I will have already taken my monthly salary of £12,000 up to the end of March.”

‘Bonus v dividend’ calculations

Suzanne promised to let Alan have some figures so he could make an informed decision. She prepared a spreadsheet that showed the relevant tax and NICs costs of paying £100,000 either as a bonus or a dividend. The spreadsheet tax calculations assumed that Alan already had a £120,000 salary for 2023/24 and had £15,000 of other income.

Suzanne emailed this spreadsheet over to Alan the next morning, which contained the following workings:

Company position: Estimated for year ended 31 March 2024		Bonus	Dividend
		£	£
Estimated profit for year before director's further 'draw' (say)		650,000	650,000
Less: Proposed bonus (including) employer NICs		(100,000)
Estimated trading profit for year ended 31 March 2024	550,000		650,000
Corporation tax @ 25% (see below)		(137,500)	(162,500)
Post-tax profit		412,500	487,500
Retained profits brought forward		260,000	260,000
Less: Proposed dividend			(100,000)
Estimated retained profits carried forward at 31 March 2024		672,500	647,500

Alan’s position		£	£
Amount earmarked for bonus/dividend		100,000	100,000
Employer’s Class 1 NICs (see note 1)		(12,126)
Gross bonus/cash dividend		87,874	100,000
PAYE/NICs on bonus of £174,627
PAYE – £87,874 x 45% (see note 2)		(39,543)
Employees’ NICs – £87,874 x 2% (see note 3)		(1,758)
Dividend tax
Additional top rate of £99,000 x 39.35% (see note 4)			(38,957)
Net cash available for Alan		46,573	61,043
Corporation tax saving with bonus – £100,000 x 25% (note 5)		25,000
Overall net cash available to Alan/company		72,573	61,043

Notes

The employer’s NICs cost must be met from the allocated £100,000. Since Alan is a director, his employer’s NICs is calculated on an annual basis. His salary has already used up his ‘exempt’ amount, and hence, the full bonus would be subject to 13.8% NICs. The NICs liability on the bonus is £12,126 - £100,000 x (13.8%/113.8%).

Given the level of Alan’s salary and other income, his marginal income tax rate for this comparative calculation is 45% (he is unable to claim any personal allowance).

Being a director, Alan has an annual earnings period for NICs purposes. His salary would have used all his director’s (employee’s) NICs blended 11.5% band for 2023/24; hence, the additional employee’s NICs on his bonus would be taxed at the 2% NICs rate.

If Alan were to receive a £100,000 dividend instead, this would be taxed as the highest level of his income. Thus, all the dividend (less the £1,000 dividend allowance for 2023/24) would be subject to the additional dividend tax rate of 39.35%.

It is sometimes overlooked that the higher corporation tax rate of 25% increases the level of tax savings by paying a bonus.

Follow-up

After receiving Suzanne’s email and spreadsheet, Alan arranged a Zoom call with Suzanne. “Thank you for your spreadsheet, Suz. Based on your figures, it looks like it is better to pay me a bonus – is that right?”

Suzanne reacted: “Yes, as you can see from my spreadsheet, when we also consider the corporation tax saving, there is a useful cash benefit of taking the bonus. However, your bonus would be subject to an immediate deduction for PAYE and NICs. On the other hand, since you have not taken any bonuses or dividends these past few years, you do not have to pay any dividend tax until 31 January 2025. And what is more, you should be able to get a decent interest return on these funds until then. Nevertheless, I still think you will be marginally better off taking a bonus. The other thing that you might consider is taking out some of your bonus as a pension contribution. You will recall the annual allowance is now increased to £60,000 but equally important, the lifetime allowance has effectively been scrapped, so you will not be penalised by topping-up your pension fund now. The Labour Party says it intends to reinstate the lifetime allowance, but I think you should be okay with monies placed into your pension pot before any change in the law.”

Suzanne added: “We could also generate some savings by passing some of your shares to your wife – and then re-designating them as a separate class of shares. This will enable you to place some £50,000 or so dividend at a much lower tax rate. The shares given to your wife will have to enjoy full rights to vote, dividends, and capital. Have a think about it?”

Alan thanked Suzanne for all her help. She had made him see everything more clearly and he reflected how fortunate he was to have such a ‘savvy’ accountant and tax adviser!

Practical tip

Directors must always ensure that the company has sufficient distributable profits to ‘frank’ the proposed dividend payment, otherwise it will be unlawful and HMRC is likely to require the company to pay a loan to participator tax charge (33.75% for the year to 31 March 2024).