Every UK company director eventually asks the same question. Should profits come out as salary, dividends, or a mix of both?
The answer changed again this year. Dividend tax rates in 2026/27 rose for the second time in three years, and that shift has quietly altered the maths behind the classic low-salary, high-dividend strategy. Dividends can still offer tax advantages, but the right salary vs dividends strategy depends on your company profits, other income, corporation tax, and national insurance.
This guide explains the current rates, shows how tax on dividends works, and explains why your salary and dividend strategy deserves an annual review.
Key Takeaways
- Dividend tax rates 2026/27 increased, with the basic rate rising to 10.75% and the higher rate reaching 35.75%.
- Salary vs dividends decisions should be reviewed annually because tax rates, allowances and National Insurance thresholds change.
- Tax on dividends depends on your total income, not just the amount of dividends you receive.
- Salary can reduce company profits for Corporation Tax purposes, while dividends come from post-tax profits.
Why Directors Should Review Their Tax Strategy
Many directors set their salary and dividend split years ago and never revisit it. That’s a mistake. Personal allowances, dividend rates, and National Insurance thresholds move independently of each other. A structure that worked well in 2022 can quietly cost you hundreds of pounds a year by 2026, without any obvious trigger.
This year brought a real change. Dividend tax rates increased by two percentage points from April 2026, pushing the basic rate from 8.75% to 10.75% and the higher rate from 33.75% to 35.75%. For directors taking meaningful dividend income, that increase adds up fast.
Dividend Tax Rates 2026/27 Explained
HMRC confirms the current dividend tax bands for the 2026 to 2027 tax year on GOV.UK’s dividend guidance page. The rates apply once dividend income exceeds your available allowances.
|
Tax band |
Dividend tax rate |
|
Basic rate |
10.75% |
|
Higher rate |
35.75% |
|
Additional rate |
39.35% |
Every individual gets a £500 dividend allowance each tax year. Dividends within this allowance are tax-free, regardless of which income tax band you fall into. Your salary, rental income, pension income, and other taxable income can affect the tax on dividends you receive.
Your tax band depends on total income, not dividends alone. If your salary and dividends together push you into the higher rate band, only the portion above the basic rate threshold gets taxed at 35.75%.
Worked Example
Consider a director with a £12,570 salary and £25,000 in dividends. Assume they have no other income.
The salary uses the director’s personal allowance. The first £500 of dividends falls within the dividend allowance. The remaining £24,500 is taxed at the basic dividend rate of 10.75%. That creates a dividend tax liability of approximately £2,634.
The comparison changes if the director receives the same £25,000 as additional salary. The extra salary may be subject to income tax and employee national insurance. The company may also face employer national insurance.
The company may claim salary as an allowable expense. Dividends do not reduce the company’s taxable profits.
This means the most accurate salary vs dividends comparison must consider both personal tax and the company’s corporation tax position.
The example also shows why the lowest personal tax bill does not always produce the lowest overall tax cost. Company-level taxes and National Insurance can change the final result.
How Salary and Dividends Differ
The two extraction methods work in fundamentally different ways, and understanding the mechanics matters more than memorising the rates.
|
Feature |
Salary |
Dividends |
|
Tax charged |
Income tax + National Insurance |
Dividend tax only, no NI |
|
Corporation tax impact |
Deductible reduces taxable profit |
Not deductible |
|
Tax rates (2026/27) |
20% / 40% / 45% |
10.75% / 35.75% / 39.35% |
|
Paperwork |
Payslip, RTI submission |
Board minute + dividend voucher |
|
Tax paid via |
PAYE, in real time |
Self Assessment, due 31 January |
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Salary goes through PAYE. It attracts income tax and National Insurance, but the company deducts them as business expenses before calculating corporation tax. Salary also builds your State Pension record and supports mortgage applications, since lenders generally prefer documented PAYE income.
Dividends come from post-tax company profits. They carry no National Insurance charge at all, and the rates above sit well below equivalent income tax bands. However, dividends are not a deductible expense, so they don’t reduce your company’s corporation tax bill the way salary does.
This difference explains why most limited company directors combine both. A low salary uses the personal allowance efficiently and protects pension entitlement. Dividends then top up income at a lower overall tax cost.
The Employer National Insurance Catch
The strategy isn’t cost-free. Employer National Insurance sits at 15% on salary paid above the secondary threshold, which is roughly £4,992 a year, according to HMRC’s National Insurance rates guidance. A salary set at £12,570 generates employer NI of around £1,137.
That charge is itself deductible against corporation tax, reducing the real cost to somewhere near £850 a year at the main 25% rate. For companies paying the small profit rate of 19% instead, the relief is smaller, which shifts the balance slightly further toward dividends over salary at lower profit levels.
Sole directors without other employees should also check their Employment Allowance eligibility carefully. Most single-director companies with no other staff cannot claim it, which changes the employer NI calculation entirely.
Choosing the Right Salary Level
There’s no single correct salary figure. The right answer depends on your company’s profit band, associated companies, and any other personal income you receive.
Three approaches come up most often in practice:
• Salary at the lower earnings limit, around £6,708 a year, secures a qualifying year toward the State Pension without triggering any actual National Insurance liability. It sacrifices some corporation tax relief compared with a higher salary.
• Salary at the personal allowance, roughly £12,570, remains the most common approach for sole directors. It uses the full income-tax-free allowance while keeping employee NI at zero, and the employer NI cost is largely offset by corporation tax relief.
• Salary into the basic rate band occasionally makes sense for companies paying the main 25% corporation tax rate. Some directors accept 20% personal tax on income above the personal allowance because it still nets a gain against the higher corporation tax saved.
Marginal Relief Changes the Calculation
Companies with profits between £50,000 and £250,000 fall into the marginal relief band, where the corporation tax rate tapers gradually between 19% and 25%. A higher director’s salary reduces taxable profit, and for some companies, this pushes profits back into a lower effective rate.
This makes the salary vs dividends decision genuinely different for growing companies compared with those already well above the marginal relief ceiling. A corporation tax review alongside your salary planning often uncovers savings that a dividend calculator alone won’t show.
Reporting Dividends Correctly
Dividend income above the £500 allowance must go on your Self Assessment return. HMRC doesn’t collect dividend tax at source, so the liability builds through the year and falls due on 31 January following the end of the tax year.
This creates a genuine cash flow risk for directors who don’t plan ahead. Many small business owners underestimate how much they’ll owe until the Self Assessment deadline is close, and unpaid tax then attracts interest from the due date. Setting aside dividend tax monthly, rather than treating it as a January surprise, avoids that scramble.
Directors filing their own returns should also review our guide to Self Assessment , particularly if dividend income sits alongside rental income or freelance earnings, since combining income sources can push you into a higher band without much warning.
Common Mistakes That Cost Directors Money
In director tax reviews, a few common mistakes appear repeatedly.
- Paying dividends without distributable reserves. Dividends can only come from retained, post-tax profit. Paying one when the company has no distributable surplus is unlawful, regardless of how much cash sits in the business bank account.
- Skipping the paperwork. Every dividend needs a board minute and a dividend voucher, even for a sole director and shareholder. HMRC can and does query dividends that lack proper documentation during enquiries.
- Underestimating the January tax bill. Because dividend tax isn’t deducted at source, directors sometimes spend the money before setting aside the tax portion, then face a cash flow squeeze at the Self Assessment deadline.
- Confusing loan repayments with dividends. Money you’ve personally lent the company and are being repaid isn’t salary or a dividend. It follows separate rules, and mixing the two up creates confusion during any HMRC review of a director’s accounts.
Getting Your Structure Right
Dividend tax rates 2026/27 make this year’s salary vs dividends decision more important than it’s been in some time. A two percentage point rise sounds modest, but it changes the exact break-even point between salary and dividend income for thousands of UK directors.
Reviewing your extraction strategy annually, rather than leaving it on autopilot, protects both your take-home income and your compliance position. If you’d like a personalised salary and dividend review for your company, book a free consultation, and we’ll model the most efficient structure for your specific profit level and circumstances.
