Go Limited - An Easy Guide to Understanding Dividends for Limited Companies
Go Limited - An Easy Guide to Understanding Dividends for Limited Companies
Regardless of how long you've been contracting for, if you currently run a limited company or you've thought about running one, you have probably come across dividends. In fact, dividends are one of the main reasons why many contractors decide to make the transition from operating as a sole trader, freelancer or umbrella company contractor, and set up a limited company. However, dividends can be confusing at first, especially if you haven't had much limited company experience.
At Go Limited, we understand the complexities of dividends, but we're here to help. Below, we've taken a look at how dividends work, why they're so popular with contractors and the main mistakes you need to avoid, all of which will help you to make informed decisions about paying yourself.
The Basics: What Are Dividends?
Dividends are payments made to a limited company shareholder, and they come from the profits of the business. They're a way to 'reward' shareholders for the success of a business, which is what makes owning shares in the company worthwhile. As a limited company director, you are a key shareholder, often the only one.
Your limited company earns income from clients, by you completing various projects. Once you have deducted allowable business expenses - such as equipment, travel, accountancy fees, and software - and your business has paid Corporation Tax, the profits are left. These profits can then be distributed to shareholders as dividends. If you're the sole director and shareholder of the business, you can pay yourself from the profits in the form of dividends.
Here's Why Limited Company Contractors Need to Understand Dividends
As a limited company contractor, you need to understand dividends for a variety of reasons. If you're using dividends to pay yourself, which many contractors do, you need to make sure you're compliant. HMRC has a set of very strict rules around how dividends should be declared and recorded, and making mistakes can put you in hot water. Plus, if you're not completely clear on how dividends work, you might end up paying unnecessary tax.
You can use dividends to plan your cash flow, as you're not tied to a fixed monthly salary. You have the freedom to choose when and how much you withdraw, which can be helpful if your income fluctuates throughout the year. Though contracting doesn't give you a fixed monthly income, you can use dividends to pay yourself a similar amount at regular intervals.
Dividends: One of the Biggest Advantages of a Limited Company
There are a lot of benefits that come with setting up a limited company for contracting, which is why many contractors choose it over being a umbrella company contractor, but being able to pay yourself in dividends is one of the biggest advantages. When you're working as a sole trader or freelancer, you don't have the freedom to pay yourself in a tax-efficient way using dividends. You also don't have this option if you choose to contract under an umbrella company. By avoiding PAYE and finding the perfect dividends versus salary benefit, you could end up with higher take-home pay.
This is because dividend tax rates are lower than the Income Tax you have to pay on a salary. Plus, dividends don't attract National Insurance Contributions (NICs) in the same way a salary does. You also have flexibility in how much to take, which allows you to plan around your tax thresholds.
Whereas basic rate taxpayers pay 20% tax on income, plus NICs, you only pay 8.75% tax on dividends. This adds up over the course of the year, leaving you with less tax to pay and more money in your pocket.
The Tax-Efficient Benefits of Paying Yourself in a Salary and Dividends
Knowing the benefits of dividends, you might be tempted to pay yourself in nothing but dividends, ignoring a salary altogether. However, this isn't usually the right approach, and most contractors prefer to strike a balance between the two. By paying yourself a small salary, you make sure that you still qualify for state pension and other statutory benefits, which you couldn't get if you were only paid in dividends. You can then top up this small salary with dividends, taking your income to what it should be.
By setting up a limited company and balancing dividends and salary, you minimise both Income Tax and NICs, stay compliant with HMRC, take advantage of your personal income allowance, and take advantage of your dividend allowance.
Avoid These Contractor Dividend Pitfalls
There's no denying the benefits of dividends, but there are some common mistakes to avoid.
Paying Dividends Without Enough Profits
You can only pay dividends out of the business' post-tax profits. If you pay yourself dividends when your limited company doesn't have enough money, you could find yourself in legal trouble and facing unexpected tax bills.
Not Keeping Up With the Paperwork
You need to keep on top of dividend paperwork, even if you are the only director and shareholder. This means keeping board minutes when you're declaring dividends, and creating dividends vouchers as part of the process. HMRC can ask to see your documents relating to dividends, and missing records can cause compliance problems.
Getting Dividends and Salary Confused
Dividends are not a form of salary, and they're not a replacement for all of your income. If you pay yourself nothing but dividends - for example, you don't pay yourself a salary - you might save on NICs, but you might also lose your entitlement for state benefits. It's also a potential HMRC red flag, and you don't want to find yourself under the microscope.
Not Timing Dividends Correctly
Though there's a lot of freedom surrounding when you can pay yourself dividends, you do need to do a little bit of planning. Taking a large dividend just before the end of the tax year might push you into a higher tax bracket, increasing how much tax you'll have to pay. Basic rate taxpayers are charged 8.75%, but this increases to 33.75% for higher rate taxpayers. It's usually best to strategically spread dividends throughout the year, as this can help you to make the most of allowances and avoid paying higher rates unnecessarily.
Not Planning for Personal Tax
Dividends are taxed personally, which means that you need to
keep savings aside to cover the cost. You'll need to submit a Self-Assessment Tax Return annually, as is the case for other self-employed contractors, and then pay the tax you owe. If you don't plan ahead, you could find yourself struggling to cover the cost, which leads to
HMRC fines and penalties.
The Importance of Getting Professional Dividend Advice
Understanding the basics of dividends is essential, but managing them effectively is where many contractors can slip up and make a mistake. Dividends are subject to specific rules, allowances and tax implications, all of which can change depending on your income and HMRC rules. This is why speaking to a specialist contractor accountant is so valuable, and why it's something a lot of limited company contractors choose to do.
When you have a limited company accountant helping you manage dividends, you can relax, knowing that you're paying yourself with the right balance of salary and dividends for maximum tax efficiency. They can also ensure dividends are declared correctly with the proper paperwork, keeping you compliant with HMRC. A limited company accountant can also advise on timing withdrawals to avoid pushing yourself into a higher tax bracket unnecessarily, and keep you up to date with HMRC rule changes that could affect your income.
If you do attempt to manage dividends yourself and you make a mistake, you could find yourself facing costly challenges. For example, taking dividends without sufficient retained profits could result in illegal dividends, and failing to account for dividend tax in advance might leave you scrambling to pay an unexpected bill when Self-Assessment Tax Return time comes around. An accountant doesn't just keep you compliant, they can save you money and give you peace of mind, leaving you free to focus on winning contracts, keeping clients happy and delivering great work.
At
Go Limited, we know that dividends are one of the main reasons why setting up a limited company for contracting can be so rewarding. They give you flexibility, tax efficiency and the ability to control how you pay yourself. But, there's a fair amount of responsibility that comes with dividends. You need to understand the rules, keep proper records and plan ahead to avoid costly mistakes, all of which our experts can help you with. By combining a salary with dividends, and avoiding common pitfalls, you'll be able to keep more of your hard-earned income.
FAQ:
1. What are dividends for contractors?
Dividends are payments made to company shareholders from profits that remain after all business costs and Corporation Tax have been paid. For contractors who operate through their own limited company, dividends are one of the main ways of paying themselves. Unlike a salary, which is processed via PAYE, dividends are a distribution of profits rather than an expense. This makes them a flexible way to draw money from the business, provided the company is profitable.
2. How are dividends different from salary?
The key difference is how each is taxed. Salary counts as an expense for the company, reducing taxable profits but attracting both Income Tax and National Insurance contributions. Dividends are not treated as a business expense and can only be paid from post-tax profits. The advantage is that dividends are not subject to National Insurance, making them more tax-efficient than salary. Contractors often choose a combination strategy: paying themselves a modest salary (often at the National Insurance threshold) and topping up their income with dividends.
3. When can I pay myself dividends?
Dividends can only be declared if your company has enough retained profit after covering all obligations, such as business expenses, salaries, and Corporation Tax. It's illegal to pay dividends from anything other than profit. For example, if your company has £15,000 profit after tax, you may distribute all or part of that as dividends. If you accidentally take too much, it will be treated as a director's loan and may have tax consequences.
4. How are dividends taxed?
Dividend tax is separate from normal Income Tax. For the 2025/26 tax year:
1. The first £500 of dividend income is tax-free (dividend allowance).
2. Dividends falling within the basic rate band are taxed at 8.75%.
3. Dividends in the higher rate band are taxed at 33.75%.
4. Dividends in the additional rate band are taxed at 39.35%.
For example, if you earn a salary of £12,570 (using up your personal allowance) and then take £30,000 in dividends, a portion of that will be taxed at 8.75% and the rest at 33.75%, depending on which income band you fall into. An accountant can help calculate the most efficient split for your personal circumstances.
5. Can I take only dividends and no salary?
Some contractors are tempted to avoid salary altogether and rely only on dividends. While this might seem more tax-efficient, it carries risks. HMRC expects directors to take at least a small salary to reflect their role, and only dividends without salary can look suspicious. A salary also counts towards National Insurance contributions, which affect your state pension and benefits entitlement. For these reasons, most contractors take a low salary plus dividends instead of dividends alone.
6. How often can I take dividends?
There are no rules on frequency. You may declare dividends monthly, quarterly, annually, or whenever profits are available. Many contractors mirror a regular income pattern, paying themselves dividends each month alongside their salary. Others prefer to wait until the end of the financial year when profits are clearer. The important part is that dividends must be properly declared and supported by paperwork, regardless of frequency.
7. What paperwork do I need for dividends?
Even if you're the sole director and shareholder, you must complete the correct paperwork when paying dividends. This includes:
1. A board meeting minute (even if it's just you) recording the decision to pay dividends.
2. A dividend voucher for each payment, showing the company name, shareholder name, date, and dividend amount.
This documentation ensures the dividend payment is legitimate and helps protect you in case HMRC reviews your company records.
8. How do dividends work if I'm caught inside IR35?
If your contract falls inside IR35, the majority of your income is deemed "disguised salary" and subject to PAYE tax and NICs. This leaves little or no profit in the company to pay out as dividends. In this situation, most of your income is taxed as salary, making dividends largely irrelevant. Contractors inside IR35 often work through umbrella companies instead, where dividends are not available at all.
9. Can I split dividends with my spouse?
Yes, if your spouse is a shareholder in your limited company, they are entitled to dividends in proportion to their shareholding. This can be a very effective tax-planning strategy if your spouse is in a lower tax bracket. For example, if you each hold 50% of the shares, any dividends must be split equally. You can't simply "assign" more dividends to your spouse unless the shareholding structure supports it. It's best to set this up properly with professional advice to avoid any issues with HMRC.
10. What happens if I take more dividends than my company's profits?
If you take more money than your company has available in retained profits, the excess is classed as an overdrawn director's loan account. This can lead to additional tax charges under Section 455 Corporation Tax rules if the loan isn't repaid within nine months of the year-end. It also creates potential personal tax liabilities. The best practice is to check retained earnings carefully before declaring dividends and keep proper accounting records.
11. Do umbrella company contractors receive dividends?
No. Umbrella workers are employees of the umbrella company and are paid through PAYE, which means they receive salary only. Dividends are only relevant to contractors who operate through their own limited company, where they are both director and shareholder.
12. Do I need an accountant to handle dividends?
While you can technically manage dividends yourself, most contractors rely on an accountant. An accountant will make sure that:
1. Dividends are only paid from profits.
2. Tax is calculated accurately.
3. All paperwork is in order.
4. You avoid accidentally creating an overdrawn director's loan account.
Given the potential penalties for mistakes, many find the cost of professional support worthwhile for peace of mind and tax efficiency.
Important:
Please note: Any rates and thresholds mentioned in this article are correct at the time of publishing and may be subject to change.
When choosing an accountant, look for one with proven experience and expertise in the contracting sector, particularly around areas like IR35, limited company tax matters and off-payroll working. Formal qualifications are important, but relevant hands-on knowledge matters just as much — especially in a complex and fast-changing landscape like this.
