If you run your own limited company, one of the biggest tax decisions you’ll make every year is how to pay yourself: salary, dividends, or a mix of both. Get the split right, and you keep more of what the company earns. Get it wrong, and you pay more Income Tax, dividend tax, or National Insurance than you needed to. This guide covers current 2026/27 rates and how the salary-dividend decision actually works.
Salary vs Dividends: The Basic Difference
A salary is paid through PAYE, like any employee’s wages, and is subject to Income Tax and National Insurance, both employee and employer contributions. It’s also a deductible business expense, reducing the company’s Corporation Tax bill. Dividends, by contrast, are paid out of profit after Corporation Tax has already been deducted, and are taxed at separate dividend tax rates rather than Income Tax rates. This difference in treatment is exactly why most director-shareholders use a combination of both rather than relying on one alone.
Dividend Tax Rates for 2026/27
| Band | Dividend Tax Rate |
|---|---|
| Dividend allowance | £500 tax free |
| Basic rate | 10.75% |
| Higher rate | 35.75% |
| Additional rate | 39.35% |
Only the first £500 of dividend income is tax free each year. Everything above that is taxed according to which Income Tax band your total income falls into, worked out after your salary and any other income is added on top.
Why Most Directors Use a Salary and Dividend Combination
A common approach is to pay a small salary, often set around the National Insurance threshold, so it counts toward your state pension record without triggering employee or employer National Insurance, then take further income as dividends above that. This structure captures the tax-free Personal Allowance through salary, keeps the company’s Corporation Tax deduction for the salary portion, and takes the rest at generally lower dividend tax rates than the equivalent salary would cost.
The exact optimal split depends on your total income, other earnings, and how much profit the company has available. Our guide to Corporation Tax for small businesses explains how company profit is taxed before any dividend can be declared.
Important Rules Around Paying Dividends
- Dividends can only be paid from retained profit after Corporation Tax, not from turnover
- You must hold a formal board meeting and produce dividend vouchers, even in a one-person company
- Paying a dividend when the company doesn’t have sufficient distributable profit is unlawful and can be reclassified as a loan or salary by HMRC
- Dividends must be paid in proportion to shareholding, unless you have different share classes set up
This is why accurate business record keeping matters just as much for dividends as it does for expenses. HMRC can and does check whether a dividend was genuinely supported by profit at the time it was declared.
How Dividends Are Reported and Taxed
Dividend income above the £500 allowance must be reported to HMRC. If it’s your only untaxed income and stays under £10,000, HMRC may be able to collect the tax by adjusting your PAYE tax code. Above that, or if you have other reasons to file, you’ll report dividends through Self Assessment. Our guide to Self Assessment tax returns covers the registration and filing process in full.
Salary Considerations: PAYE, National Insurance and Payroll
Running a salary through PAYE means registering as an employer, even if you’re the only person on the payroll, and submitting regular reports to HMRC. Our guides to payroll for small businesses and how PAYE tax is calculated cover the mechanics, while our guide to employer National Insurance contributions explains the employer-side cost of paying a salary above the secondary threshold.
A Simple Example
| Approach | How It Works |
|---|---|
| Salary only | Full Income Tax and both employee and employer National Insurance apply above the relevant thresholds |
| Dividends only | No salary means no qualifying years toward the state pension, and no Corporation Tax deduction for what you draw |
| Salary plus dividends | Small salary secures pension qualifying years and a Corporation Tax deduction; dividends above the £500 allowance are taxed at 10.75% to 39.35% depending on your band |
Most directors of profitable small limited companies find the combined approach gives the best overall outcome, though the right numbers depend on individual circumstances and should ideally be checked against your specific accounts each year.
Frequently Asked Questions
Is it better to pay myself a salary or dividends?
Most director-shareholders use a combination: a small salary to use the Personal Allowance and secure state pension qualifying years, with further income taken as dividends, which are generally taxed at lower rates than salary above that point.
How much dividend allowance do I get in 2026/27?
£500 tax-free per year. Dividend income above that is taxed at 10.75%, 35.75% or 39.35%, depending on your Income Tax band.
Do I pay National Insurance on dividends?
No. Dividends are not subject to National Insurance, which is one reason they’re often used alongside a smaller salary.
Can I pay myself a dividend if the company has no profit?
No. Dividends can only be paid from distributable profit after Corporation Tax. Paying one without sufficient profit is unlawful and can be reclassified by HMRC.
Key Takeaways
- Salary is taxed through PAYE and is a deductible business expense; dividends are paid from post-tax profit
- The dividend allowance for 2026/27 is £500, with rates of 10.75%, 35.75% and 39.35% above that
- Most directors combine a small salary with dividends for the most tax-efficient outcome
- Dividends require board minutes, dividend vouchers, and sufficient distributable profit
- Report dividend income through Self Assessment or a PAYE tax code adjustment
About the Author
This guide was prepared by the Business Mine editorial team, who research and write practical UK business, tax and finance guides. Information is checked against current HMRC guidance at the time of publication. This article is provided for general information only and does not constitute tax or financial advice; for advice specific to your circumstances, consult a qualified accountant.
