TAX EFFICIENCY

Salary, dividends and IR35: staying efficient without the guesswork

The salary/dividend split is the first tax decision most IT directors make and often the last one they revisit. Getting it right once isn't the same as it staying right every year.

Why the split exists at all

A director can take income from their company as salary, dividends, or a mix of both. Salary is subject to Income Tax and National Insurance but counts as a deductible company expense. Dividends are paid from post-Corporation-Tax profit and taxed at lower rates than salary, but carry no NI at all and don't count toward pension contribution calculations or certain state benefit entitlements in the same way salary does.

The common approach — a small salary up to the NI threshold, topped up with dividends — exists because it usually produces the lowest combined tax and NI bill for a single-director company. "Usually" is the operative word: it depends on other income, marginal rates, and what else the company is doing with its profit that year.

Where IR35 changes the calculation entirely

If a contract is caught inside IR35, the fee-payer (often the agency or end client) deducts tax and NI similarly to employment before the money reaches the contractor's company. That removes most of the flexibility the salary/dividend split otherwise offers on that income, because it's already been taxed at source. Contractors working a mix of inside- and outside-IR35 contracts in the same tax year need those two income streams treated separately, not blended into one simple split.

Allowances worth checking every year

A handful of allowances get missed even by directors who are otherwise on top of their numbers:

• The Dividend Allowance — a band of dividend income taxed at 0%, small but easy to forget when planning a distribution.
• The Personal Allowance taper — income above £100,000 starts reducing the tax-free Personal Allowance, which changes the effective marginal rate more than most directors expect.
• The Marriage Allowance — relevant where a spouse or civil partner has unused Personal Allowance and isn't a shareholder themselves.
• ISA and pension allowances — using these ahead of a large dividend distribution, rather than after, can change the tax due on that distribution.

A split that was right last year may not be right this year

Company profit, personal circumstances, other income, and the tax rules themselves all move year to year. A split set up three years ago and left untouched is one of the most common sources of avoidable tax for small company directors — not because it was wrong at the time, but because nobody revisited it.