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Dividends or Salary: What Should You Pay Yourself

One of the key decisions Irish company owners make is selecting the most beneficial method to pay themselves. This choice typically lies between two primary options: drawing a salary or receiving dividends. Each method has distinct tax implications and can significantly impact the financial well-being of both the owner and the company.

In this blog post, we’re colliding salary and dividends as a form of paying yourself as a company director. At the end of the road, you will have a clear image of best decision to make in terms of tax efficiency and financial welfare of your Irish company. So dividends vs salary

Dividend Tax Explained

Dividends are a form of income that a company pays out to its shareholders – who usually take the role of company directors. They represent a portion of the company’s profits and are distributed to shareholders according to the number of shares they own. Dividends are non-deductible tax expenses, meaning you cannot use them to reduce the Corporation tax burden at the end of the financial year.

Source: Unsplash

Key Aspects of Dividends Taxation

25% Dividend Withholding Tax (DWT): Dividends paid by a company are a subject of 25% DWT. When a company distributes dividends to its shareholders, a certain percentage of the dividend amount is withheld as tax and paid directly to the Irish Revenue Commissioners.

Non-Resident Shareholders: If you’re a non-resident shareholder, you’re exempt from DWT in Ireland, provided you complete form V2A. However, it’s essential to understand how dividends are taxed in your country of residence.

Income Tax Return: Dividends must be declared on your Irish tax return. They are subject to income tax, which varies depending on your tax bracket (20% or 40%).

Tax Credit: A 25% tax credit is available for the tax withheld, set against your tax liability. However, dividends are considered unearned income and cannot be offset by pension contributions.

Pros of Dividends

1. Tax efficiency: One of the significant advantages of dividends is their favourable tax treatment. In many jurisdictions, dividends are subject to lower tax rates than salaries, potentially resulting in tax savings.

2. Tax planning flexibility: Dividends offer more tax planning opportunities, allowing you to time dividend payments strategically to optimise your tax liability.

Cons of Dividends:

1. Profit dependency: Dividends are contingent on the company’s profitability. During lean periods or loss-making years, the payment of dividends may not always be feasible.

2. No National Insurance contributions: Dividends do not attract National Insurance contributions. While this can be an advantage in terms of reduced tax liability, it may have implications for your entitlement to certain state benefits.

3. Irregular income: Unlike salaries, dividend income can be irregular and dependent on the company’s financial performance.

Salary Tax Explained

A salary is a fixed, regular payment made for work performed. It is subject to taxation for both the employer and the employee, with the employer responsible for remitting these taxes to the Revenue. Salary is a form tax-deductible expenses meaning they can be used to reduce your tax liability. 

Source: Unsplash

Key Aspects of Salary Taxation

Shareholders as Directors: In many companies especially in early stages of running a business, shareholders also serve as directors. They often prefer a salary, particularly in the early stages of the business.

Reporting Salary Payments and Taxes: The company must register as an employer, and salaries are subject to various taxes like PAYE(Pay As You Earn), PRSI (Pay Related Social Insurance), and USC (Universal Social Charge).

Tax Deductions, Credits, and Reliefs: Gross salaries are tax-deductible for companies, reducing Corporation Tax. Additionally, employees can claim tax credits and reliefs on their salaries.

Non-Resident Directors: Non-resident directors receiving a salary may benefit from double taxation agreements, potentially entitling them to tax refunds.

Pros of Salary

1. Stability and predictability: With a salary, you have a consistent income stream, making financial planning and budgeting more straightforward.

2. State pension, benefits: Paying National Insurance contributions entitles you to benefits, such as State Pension, Statutory Sick Pay, Maternity Pay.

3. Credibility and mortgage applications: A regular salary can enhance your credibility when applying for mortgages or other forms of credit.

4. Ability to make larger pension contributions that will attract tax relief: The higher your PAYE salary, the higher the ceiling for pension contributions that will attract tax relief.

Cons of Salary

1. Higher tax liability: Salary income is subject to National Insurance contributions (for both the employee and the employer) and income tax, which can result in higher overall tax liability compared to dividends.

2. Limited tax planning: With salary income, tax planning options are relatively limited, leaving fewer opportunities to optimise your tax position.

3. Employer responsibilities: If you are an employer, paying yourself a salary involves additional responsibilities, such as Pay As You Earn (PAYE) reporting and compliance with employment regulations.

Dividends or Salary : Which is Better with Examples

FeatureSalaryDividends
TaxationPAYE deductions (income tax USC, PRSI)DWT (25%) + Income tax (20% or 40%) with DWT credit
Company Tax DeductibilityYesNo
Close Company Surcharge*Not applicable20% on undistributed profits
Tax EfficiencyGenerally better for lower earnersPotentially better for higher earners

*Close company surcharge is a tax measure applied in Ireland to certain types of companies known as “close companies.” This surcharge is designed to prevent the accumulation of passive income in these companies without distribution to the shareholders. It acts as an incentive for these companies to distribute their profits rather than retaining them indefinitely.

Let’s explore implications with an example:

Salary

If you take extra salary or a bonus from your company this salary is liable to PAYE, PRSI, and USC in the month you take it. The salary or bonus will go through payroll and you pay tax at source. You will get the net amount after taxes.

Jack owns all 100 shares of ABC Ltd and wants to take extra €15,000 out of his company. He is a higher rate taxpayer who is on an annual salary of €100,000. All his tax credits and lower rate band go against that salary. His tax rate on the extra salary will be 52% which is 40% Income Tax, 4% PRSI, and 8% USC.

Gross Salary   € 31,250

Income Tax40%€ 12,500
PRSI4%€ 1,250
USC8%€ 2,500
Total Tax52%€ 16,250

Net Salary   € 15,000

Jack has to pay extra salary of €31,250 to get a net of €15,000. The company will get a tax

deduction for this extra salary at 12.5%. The company profits will reduce by the amount of the salary. This will result in a Corporation Tax saving of €3,906 (€31,250 @ 12.5%).

When we deduct the Corporation Tax saving from the tax cost of €16,250, the next tax cost to the company is €12,344. This will be 39.5% of the additional salary figure [Personal Tax rate 52% minus CT rate of 12.5%]

Dividends

If Jack wants to extract €15,000 via dividends, Company needs to pay gross dividend of €20,000 in June 2022. The taxes are as follows.

Gross Dividend € 20,000

Dividend Withholding Tax [DWT] of 25% = € 5,000

Net Dividend € 15,000

Looking at this, you would think that the dividend is the best option. The tax liability is only €5,000 compared to €12,344 when taking the extra salary route. There will be a sting in the tail for Jack, when he files his Tax return for 2022 before the end of October 2023. He would pay tax on the gross dividend as follows:

Gross Dividend  € 20,000

Income Tax40%€8,000
PRSI4%€800
USC8%€1,600
Total Tax52%€10,400
Less Credit for DWT paid25%€5,000
Additional Tax27%€5,400

This is a timing difference. Jack gets €15,000 net in June 2022 but will have to pay an extra €5,400 tax by the 31st October 2023. This will be part of his 2022 Tax return and liability. So, for a gross dividend of €20,000, Jose’s net will get €9,600 after all taxes. In June 2022 he has the full €15,000. He will have to stump up €5,400 in 2023 to cover the taxes owing on the gross dividend.

If you need more information on how to pay your dividend, contact us. We offer a free first onboarding consultation!

Summing Up: Should I Pay Myself Dividends or Salary

When deciding between dividends and salary as a form of payment in Ireland, it’s crucial to consider the specific circumstances of your business and personal tax situation. While salary payments are tax-deductible and may offer immediate tax reliefs and credits, dividends could provide a more tax-efficient option for higher earners, despite not being deductible for Corporation Tax purposes. Ultimately, the choice should align with both your short-term financial needs and long-term business strategy. Understanding the intricate tax implications of each option is key to ensuring the financial health and growth of your Irish company.

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