Bonus or Dividend: Which Wins on Tax?

Peter Rayney reviews the current tax costs of taking bonuses and dividends.  

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For many years, the vast majority of owner-managers have been taking dividends to extract surplus profits from 'their' companies, whilst also drawing a reasonable monthly salary. Further tax savings have often been made by passing some (ordinary) shares to their spouses and paying them appropriate dividends. 

However, the cumulative effect of the recent tax changes means that dividends may no longer be the preferred extraction route for ‘surplus’ profits. The overall tax costs for bonuses and dividends now depend on the precise circumstances of each case – in many cases, paying a bonus would now give a better tax result.  

In recent years, several important tax changes have affected ‘bonus vs dividend’ comparisons, including: 

• the April 2023 rise in corporation tax to 25% for most companies; 

• across the board dividend tax increases of 1.25% in 2022, followed by a further 2% increase in the dividend basic and upper rate in April 2026; 

• the additional-rate income tax band being restricted to a £125,140 ceiling in 2023; 

• the lowering of the National Insurance contributions (NICs) employer’s threshold from £9,100 to £5,000, which meant companies started paying NICs on a much larger part of earnings; and 

• the rise in the employers’ NICs rate to 15% from April 2026. 

Where meaningful amounts are involved, it is advisable that comparative calculations are made to determine whether it is better to pay a bonus or dividend. 

National Insurance contributions  

It is often sensible to extract a reasonable salary, even if it is only sufficient salary to maintain NICs records so that each year is a qualifying year for state pension ‘accrual’ purposes.  

Directors are dealt with on an annual basis for NICs purposes. For 2026/27, they would suffer 8% NICs on their earnings between £12,570 and £50,270. An additional employee NICs charge of 2% is levied on all earnings exceeding the upper earnings limit of £50,270.  

For those owner-managers with the ‘work till you drop’ ethos, employees’ NICs cease to be payable on their earnings after they have reached ‘pensionable age’.  

Since 6 April 2026, businesses pay 15% employer’s NICs on all director’s earnings above £5,000 on an annual basis (employer NICs still remain payable for employees that have reached state pension age).  

Companies may be able to benefit from the annual employer allowance that exempts them from paying the first £10,000 of NICs (this benefit is no longer limited to smaller businesses). 

Dividends 

Dividends are always taxed as the highest slice of taxable income. Ignoring the personal allowance and the dividend allowance (now just £500), the relevant rates are as follows: 

Comparative calculations 

We are going to look at two 'typical' examples to determine whether the owner-manager should extract 'surplus' profits by way of a bonus or a dividend.  

In this context, surplus profits can be taken to mean those profits that are not required in the business after the owner manager has been paid a reasonable level of salary. 

Example 1: Bonus v dividend (1) 

Buzz lives in London and trades through ‘his’ 100%-owned company, Buzz Contractors Ltd (BCL).  

Buzz expects taxable trading profits to be around £100,000 in the year ending 31 March 2027. BCL already pays him a monthly salary of £1,048 (using up his entire personal allowance). He has no taxable benefits or other income. 

Based on all the circumstances, Buzz wishes to take out cash of some £50,000 and to determine whether this should be done by way of a bonus or dividend. 

Notes 

1. Employer’s NICs is part of the cost of taking the bonus and is part of the employer’s NICs cost – £50,000 x 15%/115%. 

2. The marginal rate of corporation tax of 26.5% applies in the year to 31 March 2027. 

3. Buzz’s salary has been covered by his personal allowance, and he has no other income. A proposed bonus of £43,479 would be taxed as follows: 

4. Buzz’s personal NICs are as follows: 

5. Buzz's dividend tax is £3,897, calculated as follows 

From a tax-cost viewpoint, it would be more attractive for Buzz to pay a dividend. There is a useful tax saving and the dividend tax is deferred until the relevant self-assessment payments are made, whereas a bonus payment would be subject to an immediate PAYE and NICs payment to HMRC. 

Example 2: Bonus v dividend (2) 

Gus is a 60% shareholder and a director of Grissom, White & Chaffe Ltd, a small precision engineering business. The company was set up on 27 January 2007 with three shareholders. It expects to make some £1.8m pre-tax profits during the year to 31 March 2027.  

During the year, Gus takes a regular salary of £12,000 per month, and the directors have agreed that he can take an additional £100,000 from the company for the year. He wants to determine whether it is best to take this as a bonus or dividend.  

Notes 

1. Employer’s NICs is part of the cost of taking the bonus and is part of the employer’s NICs cost – £100,000 x 15%/115%. 

2. Gus’s marginal income tax rate on a bonus is 45%.  

3. A bonus would entirely be within the 2% NICs charge. 

4. A proposed £100,000 dividend would be taxed at Gus’s highest slice of income. Since his annual salary takes him above the higher-rate band, the entire dividend (less the £500 allowance) would be subject to the dividend additional rate of 39.35%.  

There is only a marginal saving of paying a bonus. Nevertheless, despite the advanced tax and NICs payment through PAYE, a bonus is simpler, given there are two other shareholders of the same class. 

Some final thoughts 

The choice between bonuses and dividends may also be influenced by other factors. Thus, a relatively high bonus payment might be required to enable the owner-manager to augment their pension fund with tax allowable contributions (subject to the annual allowance limits). However, it is normally possible for owner-managers to arrange for company pension contributions to be paid (and avoid the need to generate taxable earnings), although the annual allowance rules must still be applied. 

Recent cases have also demonstrated the adverse consequences that arise for failing to pay compliant dividends under the Companies Act 2006. Owner-managers must therefore always ensure, for example, that the company has sufficient distributable profits when the dividend is paid to ‘frank’ the entire payment.