Salary versus Dividend: HW Fisher share technical considerations for year-end planning

As we approach the end of the tax year, many adviser-client conversations turn to profit extraction strategies for owner-managed businesses. Neil Maslen, Director in the private client tax team at HW Fisher, says that while the salary versus dividends question remains one of the most frequently asked, there is no one-size-fits-all answer.

The Complexity of the Calculation

The challenge advising on salary versus dividends lies in the number of variables at play. The optimal approach for a basic rate taxpayer extracting £50,000 differs entirely from that of an additional rate taxpayer extracting £200,000.

Add in differences between companies, such as whether Employment Allowance is available, the retained profits, cashflow requirements and whether there are multiple shareholders, and the number of possible scenarios quickly increases.

Tax Efficiency and the Impending Rate Change

The comparative tax cost of salary and dividends shifts substantially across income bands, making personalised analysis essential. Salary attracts Income Tax at 20%, 40%, or 45% depending on total income, alongside employee National Insurance Contributions (NIC) at 8% on earnings between £12,570 and £50,270, then 2% above that threshold.

Employer’s NIC at 15% applies on earnings above £5,000, though this may be covered by the Employment Allowance of £10,500 where available.

Dividends present a different picture. Once you allow for the 2025/26 dividend allowance of £500, they are taxed at 8.75% for basic rate taxpayers, 33.75% for higher rate, and 39.35% for additional rate. From 6 April 2026 there will be a 2% increase in the dividend tax rate for basic and higher rate taxpayers.

This rate change creates a small window of opportunity for the current tax year. Where clients have flexibility in timing their profit extraction, accelerating dividend payments into 2025/26 before the rate increase takes effect could deliver tax savings: for a higher rate taxpayer extracting £50,000 in dividends, the difference between voting dividends before or after 6 April 2026 amounts to £1,000 in additional tax.

No NIC is levied on dividends, but equally no Corporation Tax relief is available for dividends as they are paid from distributable reserves (i.e. post-tax retained profits).

State Benefits and Pension Entitlement

Consideration of state benefits and pension entitlement shouldn’t be overlooked as the long-term implications can be substantial.

A lifetime of dividend extraction with no salary could leave someone significantly short of the full state pension, potentially costing them thousands per year in retirement.

Receiving a salary of at least £6,500 in the 2025/26 tax year earns the individual a qualifying year for state pension purposes – with 35 years needed for full entitlement.

Although no employee NIC arises on this level of salary, if the employment allowance is not available or has been fully utilised, the company will incur a £225 employer’s NIC liability. The NIC will obtain tax relief in the company, further mitigating the cost of obtaining a qualifying year, which is often considered worthwhile. 

Corporation Tax Impact

The most significant structural difference between salary and dividends is its Corporation Tax treatment.

Salary, including associated employer NICs, is deductible against Corporation Tax – dividends are not. At the 25% Corporation Tax rate for profits above £250,000, every £1,000 of salary saves £250 in Corporation Tax. For companies with profits below £50,000, the rate remains 19%, with marginal relief applying between these thresholds. This Corporation Tax saving must be weighed against the personal tax cost differential.

Conclusion

The matter of salary versus dividends has no one-size-fits-all approach. Yet as the Autumn Budget 2025 confirmed that Income Tax thresholds will remain frozen until April 2031, this fiscal drag will mean that as clients increase their income to match inflation, more will be pushed into higher tax bands. This coupled with the dividend tax rate increase creates planning opportunities for the current tax year that advisers and clients should not overlook.

For many owner-managed businesses accelerating dividend extraction into 2025/26 will deliver measurable tax savings that will no longer be available once the new rates take effect.