Salary and dividend calculator — methodology

The chain, in the order it happens

company profit before the director is paid
  − salary
  − employer National Insurance on the salary
  = profit chargeable to corporation tax
  − corporation tax
  = dividend declared

take-home = salary + dividend − income tax − employee National Insurance
total tax = company profit − take-home

The order is the argument. A salary and the employer National Insurance on it are deductible business costs, so they come out before corporation tax is worked out. A dividend is a distribution of profit that has already been taxed, so it comes out after. Every comparison that sets dividend rates against income tax rates and stops there is missing that step, and it is worth between 19.00% and 25.00% of the sum being compared.

The total tax line is the profit less the take-home, so it includes the corporation tax and the employer National Insurance the company paid. Neither ever reaches the director, and a comparison stated in personal tax alone cannot see either of them.

Why the comparison prices named levels rather than sweeping a range

Take-home is piecewise linear in the salary: between thresholds, one more pound of salary always changes it by the same amount. Its slope can only change where the tax system has a corner — where employer or employee National Insurance starts, where the personal allowance runs out or begins to taper, where an earned or dividend band begins, and where the profit left in the company crosses a corporation tax limit. A piecewise linear function takes its maximum at a corner or at an end of the range, so pricing the corners finds the best split exactly, and does it in about a dozen computations rather than several hundred.

Two of those corners are not thresholds anyone can look up, because they depend on the profit: the salary at which the remaining profit falls to a corporation tax limit, and the salary at which total income reaches the personal allowance taper. Both are found by bisection over the engines — asking what the answer is at a salary and narrowing — rather than by rearranging a formula into the page, which is the one thing a calculator page here may not do.

Corners outside the range a profit can reach are dropped rather than clamped to the end of it. A row labelled “dividends reach the additional rate” against a salary that leaves no dividend at all would be a worse answer than a missing row, and it is what the first version of the search produced.

What the salary is capped at, and why

A salary costs the company the salary plus employer National Insurance, so a company with £50,000 of profit cannot pay a £50,000 salary. Asked for one, the calculator uses the largest salary the profit covers and says so on the page.

The alternative — modelling a company that pays more than it earns — is a trading loss, and loss relief is not something this engine computes. An uncapped model does not merely answer a different question; it answers the original one wrongly, because the impossible route looks like the best one. Measured while building this page: at £100,000 of profit an uncapped model reports an optimum of a £100,000 salary and a take-home £3,350 above the real one.

Rates and limits

Both corporation tax limits are divided by the number of associated companies, which is why the calculator asks for it: two companies in a group reach the main rate at half the profit each.

Region: what is UK-wide, and what that does not mean

Corporation tax and National Insurance are UK-wide. Dividend rates and bands are UK-wide too, and Scottish rates and bands apply to earned income — the salary — only.

It does not follow that the same figures give the same answer wherever you live, and the page never says so. The salary is taxed at your own region’s rates, it decides where the dividend sits in the stack, and the personal allowance is set against whichever income produces the lowest bill (Income Tax Act 2007 s.25(2)) — so the Scottish bands can change how much allowance is worth using against the salary, and therefore how much of the dividend meets a rate above zero. The calculator computes all three regions on your own figures and shows them side by side rather than offering a rule of thumb.

Sources

• gov.uk — Corporation Tax rates and reliefsThe main rate, the small profits rate, the two limits and marginal relief — the step that decides how much of a profit a dividend can be paid from.
• gov.uk — National Insurance rates and allowancesEmployer and employee thresholds and rates. The annual figures are used, not the weekly ones multiplied by 52, because the two disagree.
• gov.uk — Tax on dividendsThe dividend allowance and the three dividend rates, which are UK-wide.
• gov.uk — Income Tax rates and allowances: current and past
• gov.scot — Scottish income tax rates and bandsScottish rates apply to the salary. They do not apply to the dividend, and they still change the answer.
• gov.uk — Employment AllowanceNot modelled. Listed because a reader whose company can claim it needs to know the employer National Insurance figure here is the one before any claim.

What it does not do

• Pensions, in any form — the largest omission on the page. There is no pension input in the calculation: not salary sacrifice, not employer contributions, not relief at source. An employer pension contribution is a deductible company cost carrying no employer National Insurance, no employee National Insurance and no income tax on the way in, which routinely makes it a cheaper route out of a company than either of the two being compared here. A reader whose plan includes a pension is looking at a partial picture, and it is stated on the calculator itself rather than only here.
• The employment allowance. Some employers can set an allowance against their employer National Insurance bill. A company whose only employee is a single director is generally not eligible, so it is not modelled, and the employer National Insurance figure shown is the one before any claim.
• Retained profit. Every figure assumes the whole post-corporation-tax profit is distributed in the year it is earned. Leaving profit in the company, and taking it later or on a winding-up, is a third route and is not compared.
• Losses. A salary the profit cannot cover is capped rather than modelled.
• Everything else on either return. Other personal income, savings interest, student loan repayments, benefits in kind, the high income child benefit charge, capital allowances, R&D relief, loans to participators and IR35 are all outside the model.
• Advice. The page reports what each split costs. It does not recommend one, and the reasons a director takes a salary that the arithmetic cannot see — a qualifying year towards the state pension, mortgage affordability, statutory maternity and paternity pay, life and income protection cover — are named on the page beside the figures rather than left for the reader to remember.