Director Salary & Dividends: Strategy for 2026–27. Part 4
(Continuation of: Director Salary & Dividends: Strategy for 2026–27)
"Many business owners understand how to generate profit. Far fewer understand how to extract that profit efficiently."
This is something we see regularly when speaking with company directors.
A business owner spends years building a successful company. They manage clients, employees, suppliers, cash flow and growth. They know their industry inside out.
But when it comes to paying themselves, many simply transfer money from the company account without considering the tax consequences.
The problem is that company profits and personal income are treated separately.
Your company is a legal entity. The money belongs to the company first. Only after profits are generated and the correct steps are followed can those profits be distributed to shareholders as dividends.
Understanding how dividends are taxed is therefore essential for any limited company director.
Dividend tax works differently from salary tax.
Dividends do not attract National Insurance contributions, which is one of the reasons they are commonly used as part of a director remuneration strategy.
However, dividends are still taxable once you exceed the available dividend allowance.
The rate you pay depends on which Income Tax band your dividends fall into:
The important point is that dividend tax is based on your total income.
It is not calculated separately.
For example, if you receive:
HMRC does not simply look at the dividends in isolation.
Your salary has already used part of your tax bands, meaning more of your dividends may fall into a higher tax bracket.
This is why two directors receiving exactly the same dividend amount can have completely different tax bills.
Let's look at a practical example.
Imagine two company directors, James and Emma.
Both own successful consulting companies.
Both decide to take £40,000 in dividends.
James has no other income.
Emma also receives £90,000 from property investments.
Although they receive the same dividend payment, their tax positions are completely different.
James may still have access to lower tax bands.
Emma may find that a significant portion of her dividends are taxed at the higher rates.
This is why dividend planning should always consider your wider financial position.
At Peter Hodgson & Co, when we advise clients on remuneration planning, we look beyond the company accounts. We review the whole picture — personal income, future plans, investments and family circumstances.
That wider view often creates better decisions.
Unlike salary, dividends are not processed through PAYE.
Instead, they must normally be reported through your personal Self Assessment tax return if they exceed the relevant allowances.
This is where good record keeping becomes extremely important.
For every dividend payment, your company should maintain proper documentation, including:
A dividend is not simply a bank transfer. The paperwork matters.
I often compare it to buying a house. The payment is only one part of the transaction. The legal documents are what prove ownership.
The same principle applies to dividends.
A surprisingly common mistake is forgetting that dividend tax is paid personally, not by the company.
The company pays Corporation Tax on its profits.
You personally pay dividend tax through your Self Assessment.
This means directors need to plan ahead.
A large dividend received today could create a personal tax liability months later.
For example, a director may withdraw £100,000 from their company account in March and feel financially comfortable.
Then January arrives.
Their Self Assessment bill is due.
Suddenly, they need to find a significant amount of money they had not budgeted for.
Good tax planning avoids these surprises.
Technically, some company directors can receive income only through dividends.
However, this is rarely the most sensible approach.
There are legal, tax and practical considerations that need to be reviewed first.
Before paying a dividend, several conditions must be met.
The company must:
A company cannot pay dividends simply because money is available in the bank account.
This is one of the biggest misunderstandings among new limited company owners.
Cash in the bank does not always equal profit.
A company may have £50,000 sitting in its account but still not have enough distributable reserves after considering unpaid expenses, tax liabilities and previous losses.
Let's say a contractor receives a large payment from a client.
The money arrives in the company bank account.
They immediately withdraw £10,000 and label it as a dividend.
Six months later, their accountant discovers that after expenses, VAT, Corporation Tax and previous losses are considered, the company did not actually have enough profits available.
The dividend may be invalid. This creates unnecessary complications.
The lesson is simple: Always check the company's financial position before declaring dividends.
A quick conversation with your accountant can prevent a much bigger problem later.
Incorrect dividends can create several issues.
They may become:
This becomes especially important when businesses grow.
A small error that seems insignificant when turnover is £100,000 can become a serious issue when a company is worth £1 million.
Professional investors, banks and buyers expect proper financial records.
If your company cannot pay dividends, there are other options.
Depending on your circumstances, you may consider:
The right option depends on your personal and business objectives.
The dividend allowance is one of the most misunderstood areas of UK tax.
Many people hear the phrase "tax-free dividends" and assume they can receive a certain amount without any consequences.
The reality is slightly different.
The dividend allowance allows individuals to receive a specified amount of dividend income taxed at 0%.
However, it does not increase your Personal Allowance. It works separately.
For example:
A director may receive salary income.
They may also receive dividends.
The dividend allowance applies only to the dividend portion.
Any dividends above that allowance are taxed according to the relevant Income Tax band.
The dividend allowance has reduced significantly over recent years.
This has changed how directors approach remuneration planning.
Previously, some business owners could extract a larger amount of profits with minimal personal tax.
Today, careful planning is much more important.
A strategy that worked five years ago may no longer be the most efficient approach.
This is why annual reviews matter.
The dividend allowance is particularly valuable for:
However, for high-income individuals, the allowance may have only a limited impact because their wider income already determines the tax rate applied to dividends.
Tax planning is not only about today's position.
It is about preparing for tomorrow.
If dividend allowances continue changing, company directors may need to consider alternative strategies, including:
For example, we recently advised a business owner approaching retirement who had accumulated significant company profits.
His original plan was simple:
"I'll just take the money out as dividends when I retire."
However, after reviewing his circumstances, we identified a more structured approach involving timing, pension planning and future succession considerations.
The result was a much smoother transition.
Good planning creates options.
Dividends remain an important tool for company directors, but they are not a shortcut to avoid tax.
A successful strategy requires balance.
The most effective approach usually involves:
✓ Paying an appropriate salary.
✓ Using available allowances efficiently.
✓ Declaring dividends only from genuine profits.
✓ Keeping proper dividend records.
✓ Reviewing your strategy each tax year.
At Peter Hodgson & Co, we help limited companies, contractors and business owners across Kent and the wider South East understand their options and make informed decisions about extracting profits.
Your company is not just a source of income.
It is an asset you are building.
The decisions you make today can influence your tax position, financial security and future opportunities for years to come.
Part 4 will cover:
Disclaimer:
The content of this blog is for general informational purposes only and should not be considered professional tax advice. The information is correct at the time of publishing but may change following future UK budget announcements or updates to HMRC guidance. Individual circumstances vary, and tax obligations can differ based on your personal situation. We strongly recommend consulting with us or a qualified tax professional to receive advice tailored to your specific needs.
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