Director salary and dividends are two different ways for an owner-managed limited company to pay money to a director who is also a shareholder. Salary is processed through payroll and can create Income Tax and National Insurance liabilities. Dividends are paid from distributable company profits and are taxed personally under the dividend tax rules.
The most suitable combination depends on the director’s other income, the company’s profits, Employment Allowance eligibility, available reserves and wider financial circumstances. There is no single salary-and-dividend structure that is automatically correct for every director.
The figures also change between tax years. For 2026/27, the Personal Allowance remains £12,570, the employer National Insurance threshold remains £5,000 and the dividend ordinary and upper rates have increased. Any arrangement based on the previous tax year should therefore be reviewed before payroll and dividends continue.
How director salary and dividends differ
A salary is a payment for the director’s work as an employee or office holder. It is an expense of the company when incurred wholly and exclusively for the business and processed correctly through PAYE.
Salary reduces the company’s accounting profit and can therefore reduce the profit subject to Corporation Tax. The company may also need to pay employer National Insurance in addition to the gross salary.
A dividend is a distribution to a shareholder based on their ownership of shares. It is not a business expense and does not reduce the company’s Corporation Tax profit.
Dividends are paid from profits remaining after Corporation Tax and other relevant adjustments. They are not subject to employee or employer National Insurance, but the shareholder may owe dividend tax personally.
HMRC’s guidance on taking money out of a limited company explains the basic differences between salary, dividends, expenses and directors’ loans.
Director salary thresholds for 2026/27
For 2026/27, the standard Personal Allowance remains £12,570. An individual with no other taxable income may therefore be able to receive salary up to this level without paying Income Tax, subject to their tax code and wider circumstances.
The employee National Insurance Primary Threshold is also £12,570 a year. For a director using the standard category, employee National Insurance is generally not payable where annual earnings remain at or below that level.
The employer National Insurance Secondary Threshold is much lower at £5,000 a year. Employer National Insurance is normally charged at 15 per cent on earnings above that threshold.
The Lower Earnings Limit for 2026/27 is £6,708 a year. Earnings at or above this level can generally preserve National Insurance credit for certain state benefits without the director personally paying employee National Insurance.
HMRC publishes the current amounts in its rates and thresholds for employers for 2026/27.
Why employer National Insurance changes the calculation
A company paying a director more than £5,000 may incur employer National Insurance even where the director personally pays no employee National Insurance.
For example, a director salary of £12,570 is £7,570 above the Secondary Threshold. At a 15 per cent employer rate, this can create employer National Insurance of approximately £1,135.50 before considering any Employment Allowance.
The employer contribution is a company cost. It reduces company cash and the profit potentially available for dividends, although salary and employer National Insurance may generally be deductible when calculating Corporation Tax.
This means the most tax-efficient salary cannot be determined by looking only at the director’s personal tax. The calculation needs to compare the company tax deduction, employer National Insurance, Employment Allowance and the personal tax treatment of alternative dividends.
Employment Allowance and director payroll
Employment Allowance can reduce an eligible employer’s Class 1 employer National Insurance liability by up to £10,500 for 2026/27.
A company where the only employee liable for employer National Insurance is also the sole director cannot generally claim Employment Allowance. A company with another employee or director paid above the Secondary Threshold may qualify, subject to the full rules.
Where Employment Allowance is available and already covers the company’s employer National Insurance liability, a higher director salary may produce a different result from a sole-director company that must pay the contribution in full.
The claim is made through payroll software using an Employer Payment Summary. Eligibility should be reviewed each year rather than assumed from an earlier claim.
The payroll and bookkeeping records should show the gross salary, employer National Insurance, allowance claimed and remaining liability to HMRC separately.
National Insurance for company directors
Directors are employees for National Insurance purposes, but their contributions normally use an annual earnings period rather than an ordinary weekly or monthly calculation.
This prevents a director from avoiding National Insurance by taking most of the annual salary in one short period while remaining below pay-period thresholds during the rest of the year.
Payroll software may use the standard annual method or an alternative method that calculates contributions during the year and performs a final adjustment.
The director’s appointment date, pay history and National Insurance category must be entered correctly. A person appointed partway through the year may have a proportionate annual earnings period under the relevant rules.
Businesses can use HMRC’s director National Insurance calculator and guidance to check current calculations.
The dividend allowance for 2026/27
The dividend allowance remains £500 for 2026/27. Dividend income falling within this allowance is taxed at zero per cent, although it still uses part of the shareholder’s Income Tax band.
Dividends that fall within any unused Personal Allowance may also be received without an immediate Income Tax charge. Salary and other taxable income are generally considered before dividend income when tax bands are calculated.
The £500 allowance is not an additional amount of income outside the tax-band calculation. It reduces the tax charged on that portion of dividend income but does not prevent the dividends from using available band capacity.
A shareholder receiving dividends from several companies has only one £500 dividend allowance for the tax year, not a separate allowance for each company.
Dividend tax rates for 2026/27
From 6 April 2026, dividend tax rates above the allowance are 10.75 per cent within the basic-rate band, 35.75 per cent within the higher-rate band and 39.35 per cent within the additional-rate band.
The ordinary and upper dividend rates are two percentage points higher than the rates applying in 2025/26. The additional dividend rate remains unchanged.
The rate applying to a dividend depends on the shareholder’s total taxable income. A dividend may be divided between more than one band where it crosses a threshold.
The current rates are shown in HMRC’s guidance on tax on dividends.
Scottish taxpayers use Scottish rates for salary and other non-savings, non-dividend income, but UK dividend rates continue to apply to their dividend income.
Dividends can only be paid from distributable profits
A company can pay dividends only where it has sufficient distributable profits. A positive bank balance does not prove that the required reserves exist.
The directors should review the company’s relevant accounts before declaring a dividend. These may be the latest annual accounts or reliable interim accounts where the position has changed since year end.
Distributable reserves broadly represent accumulated realised profits less accumulated realised losses. Current-year trading profit may be available, but the company must also consider earlier losses, Corporation Tax and other accounting adjustments.
A company that has made a profit during the month may still lack distributable reserves because of previous losses. Conversely, a company may have reserves available even where current cash is temporarily low.
The bookkeeping must therefore be current enough to provide a reasonable view of profit, liabilities and reserves before a dividend is approved.
What happens if a dividend is paid without sufficient profits?
A payment described as a dividend is not automatically valid merely because a dividend voucher was created. The company must have sufficient distributable reserves at the time the distribution is made.
If the shareholder knew, or should reasonably have known, that the company lacked sufficient profits, they may be required to repay the unlawful distribution.
The amount may instead remain on the director’s loan account until corrected. This can create additional company and personal tax consequences.
HMRC may challenge the treatment where payments have been labelled as dividends retrospectively to avoid PAYE or to clear an overdrawn loan account without proper evidence.
Directors should obtain advice promptly where historic dividends may have exceeded available reserves. The matter should not be hidden through an unsupported bookkeeping journal.
Dividend paperwork and company records
To pay a dividend, the directors should formally declare it and retain minutes of the decision. This applies even where the company has only one director.
A dividend voucher should be prepared for each payment. It should show the date, company name, shareholder’s name and amount of the dividend.
A copy should be given to the shareholder and another retained in the company records. The bank payment should agree with the amount declared and the bookkeeping entry.
HMRC’s guidance confirms that companies must retain meeting minutes and dividend vouchers supporting distributions.
Documentation cannot repair a dividend that was unlawful because sufficient reserves did not exist. The paperwork and financial capacity are both required.
Interim and final dividends
Private owner-managed companies commonly pay interim dividends during the year. These are normally declared by the directors and become due when paid or otherwise made available to the shareholder.
A final dividend may be recommended by the directors and approved by shareholders according to the company’s articles and procedures.
The date of declaration and the date the shareholder becomes entitled to the dividend can affect the tax year in which it is reported.
Creating paperwork after the tax year has ended does not necessarily move an earlier payment into the preferred tax year. Records should be completed when the dividend is properly declared.
Regular monthly or quarterly dividend reviews are generally safer than drawing arbitrary amounts and deciding their treatment at year end.
Director drawings and the loan account
Money taken from the company that is not salary, an expense reimbursement, repayment of money owed to the director or a valid dividend is usually recorded through the director’s loan account.
The account may show money lent by the director to the company or money withdrawn by the director beyond their entitlement.
Where the director owes money to the company, the account is overdrawn. This can create Corporation Tax consequences for the company and possible benefit-in-kind consequences for the director.
The rate charged on loans to participators is linked to the dividend upper rate and increased to 35.75 per cent from 6 April 2026.
The bookkeeping should record each withdrawal according to what was known at the time. Personal spending should not be posted automatically as wages or dividends merely to avoid showing an overdrawn balance.
Corporation Tax and director remuneration
Salary and employer National Insurance can normally reduce the company’s taxable profit where they are incurred wholly and exclusively for the business.
Dividends are paid after Corporation Tax and do not reduce the company’s taxable profit. This is an important part of the salary-versus-dividend comparison.
The Corporation Tax rate applying to the company can depend on its profit level, associated companies and eligibility for marginal relief. The effective value of a salary deduction therefore varies between companies.
Our guide to Corporation Tax deadlines explains the distinction between the company’s payment deadline and the filing deadline for its Company Tax Return.
A director should not compare personal dividend tax with salary tax while ignoring the Corporation Tax already paid before a dividend becomes available.
A salary at the Secondary Threshold
One possible approach for a sole director with no Employment Allowance is a salary around the £5,000 Secondary Threshold. This can avoid employer National Insurance, but it remains below the £6,708 Lower Earnings Limit.
A salary below the Lower Earnings Limit may not create a qualifying National Insurance year through that employment. The director’s wider contribution record therefore needs to be considered.
This approach may be relevant where the director already receives National Insurance credits or has sufficient qualifying years, but it should not be adopted without checking the personal position.
The company also receives a smaller Corporation Tax deduction than it would from a higher salary.
A salary at the Lower Earnings Limit
A salary around the £6,708 Lower Earnings Limit may help the director receive National Insurance credit without paying employee National Insurance.
However, the amount above the £5,000 Secondary Threshold can create employer National Insurance for a company that cannot claim Employment Allowance.
This may still be worthwhile when the value of the Corporation Tax deduction and National Insurance record are considered. The answer depends on the company’s tax position and the director’s contribution history.
Thresholds should not be used as payroll figures without checking whether the director began during the year or has another relevant employment.
A salary at the Personal Allowance
A salary of £12,570 may use the director’s full standard Personal Allowance where they have no other taxable income and an appropriate tax code.
It is also at the employee National Insurance Primary Threshold, so the director may pay no employee National Insurance under the standard annual calculation.
The company can face employer National Insurance on the amount above £5,000 unless Employment Allowance or another relief applies.
The higher salary creates a larger Corporation Tax deduction and reduces the amount that would otherwise need to be distributed as dividends.
Whether it is better than a lower salary depends on the company’s Corporation Tax rate, Employment Allowance eligibility, dividend rates and the director’s other income.
Why there is no universal optimum salary
A sole director without Employment Allowance may reach a different result from a company employing several people and already using the allowance.
A director with another salary, pension, rental income or substantial dividends may have little or no Personal Allowance available.
A company with low profits may not obtain immediate value from a larger salary deduction, while a profitable company paying Corporation Tax at a higher effective rate may receive more benefit.
State Pension history, student loans, High Income Child Benefit Charge and personal cash requirements can also change the preferred structure.
Salary and dividend planning is therefore a tax-planning exercise requiring company and personal information. It should not be based on a generic figure copied from social media or an article written for a different tax year.
Paying dividends to more than one shareholder
Dividends must normally be paid according to the rights attached to each class of shares. Shareholders holding the same class are generally entitled to the same dividend rate per share.
A company cannot simply choose to pay one ordinary shareholder and exclude another holding identical shares because the second person has already used their tax allowance.
Different share classes may carry different rights, but the company’s articles, share issue and commercial purpose must support the arrangement.
Changes to share ownership can have company-law, employment, tax and family-law consequences. Professional advice should be obtained before shares are issued or transferred primarily to alter dividend taxation.
Dividends paid to a spouse or civil partner are not automatically invalid, but the person must genuinely own the shares and have the corresponding rights.
Director salary and dividends with other income
Other income affects how salary and dividends are taxed. This can include employment income, pensions, property income, interest and dividends from other companies.
A director with another employment may already have used the Personal Allowance and basic-rate band. Additional company salary or dividends may therefore be taxed at higher rates.
Income above £100,000 can reduce the Personal Allowance by £1 for every £2 of adjusted net income above that level. This can create a high effective marginal tax rate.
Income may also affect Child Benefit, student loan repayments, pension annual allowance calculations and other tax matters.
The company bookkeeper will not necessarily have access to the director’s full personal tax position. Personal tax planning should therefore be completed with an appropriately qualified adviser.
Reporting salary through payroll
Director salary must be processed through PAYE payroll and reported to HMRC using a Full Payment Submission on or before the relevant payment date.
The payroll should use the correct director National Insurance method, tax code and appointment date. The company must retain payslips, payroll reports and submission confirmations.
The accounting entry should record gross salary, employee deductions, employer National Insurance, net pay and liabilities due to HMRC.
Posting only the net payment as wages understates the salary expense and omits the payroll liabilities.
Our guide to PAYE and National Insurance explains payroll reporting, employer contributions and reconciliation in more detail.
Recording dividends in the bookkeeping system
Dividends should be posted to equity or retained earnings according to the accounting software and reporting structure. They should not be entered as wages, subcontractor costs or ordinary business expenses.
The payment should be matched to the relevant dividend declaration. Where a dividend is credited to the director’s loan account instead of being paid immediately, the records should show the date the shareholder became entitled to it.
Dividend balances should agree with the board minutes, vouchers, bank account and shareholder records.
Regular bank reconciliation can identify personal withdrawals and payments that have not yet been supported by payroll, dividend or loan-account records.
Preparing for Self Assessment
Salary is normally reported to HMRC through payroll and may appear in the director’s Personal Tax Account. Dividends may need to be reported separately through Self Assessment or another HMRC process.
The director should retain dividend vouchers and details of salary, benefits, expenses and other personal income for the tax year.
A company director is not required to file Self Assessment solely because they hold that office. A return may still be needed because of dividends, property income, gains, High Income Child Benefit Charge or another filing reason.
Our guide to Self Assessment penalties explains the filing timetable and charges that can arise where a required return is late.
Reviewing remuneration before the company year end
Director remuneration should be reviewed before decisions are implemented, not reconstructed after the tax or accounting year has ended.
The company should know its current profit, estimated Corporation Tax, distributable reserves and cash commitments before declaring further dividends.
Payroll changes should be processed through the relevant pay period. A salary cannot necessarily be backdated after the year has ended simply because a different figure would have produced a lower tax bill.
The review should also identify overdrawn director loan accounts, benefits, pension contributions and expenses paid personally by the director.
Current bookkeeping makes this review more reliable because the figures are based on reconciled transactions rather than an estimate from the bank balance.
Common director salary and dividend mistakes
A common mistake is drawing money regularly and deciding at year end that every withdrawal was a dividend, even though no dividends were declared and sufficient reserves may not have existed.
Another is paying a salary without operating payroll or submitting the required Real Time Information reports.
Directors may also confuse company cash with distributable profit, overlook earlier losses or fail to allow for Corporation Tax before declaring a dividend.
Some companies pay different amounts to shareholders holding the same class of shares without considering their legal rights.
Other errors include posting dividends as expenses, failing to retain vouchers and leaving personal purchases hidden within business costs.
When outsourced bookkeeping helps
Accurate monthly bookkeeping can show company profit, tax liabilities, reserves and director loan movements before remuneration decisions are made.
The service scope should identify responsibility for payroll processing, dividend records, director loan accounts and the provision of information to the company accountant.
Bookkeeping Packages Ltd provides bookkeeping services for UK limited companies, including regular transaction processing and reconciliation according to the agreed scope.
Our payroll services can process director salaries and submit the required payroll reports where payroll forms part of the engagement.
Where responsibility for the complete monthly bookkeeping workflow needs to be transferred, our outsourced bookkeeping service explains how support can be structured.
To discuss your company bookkeeping, payroll records and director loan account, use the Bookkeeping Packages enquiry form.
About the Author
Stuart Kerr is Managing Director of Bookkeeping Packages Ltd, an outsourced bookkeeping service supporting UK small businesses and accountancy practices. With over 20 years of bookkeeping experience, Stuart specialises in helping businesses maintain reliable financial records and useful management information.
This article is provided for general information only. Stuart Kerr is a professional bookkeeper, not a tax, legal or regulated financial adviser. Nothing in this article constitutes personal tax planning, legal or financial advice. Advice specific to the company and director should be obtained from appropriately qualified professionals.