𝓤𝓷𝓲𝓽𝓮𝓭 𝓝𝓮𝔀𝓼

For small and medium business owners in 2026, the question of whether to pay yourself through salary or dividends remains one of the most important tax-planning decisions.

“How you pay yourself as a business owner – through salary, dividends, or a mixture of both – can have a big impact on your tax bill and overall financial resilience,” says Clare Stinton, senior personal finance analyst at financial services company Hargreaves Lansdown.

“Each option is taxed differently and comes with trade-offs,” she adds.

Any salary you pay yourself will be subject to income tax and national insurance, so how much you take will determine which income tax band you fall into – the 20 per cent basic rate tax, 40 per cent higher rate tax or the 45 per cent additional rate tax.

Dividends, by contrast, are paid from profits after corporation tax has already been deducted.

Do small business owners pay tax on dividends?

Dividends can often reduce an immediate tax liability. They aren’t subject to national insurance, and although dividend tax applies on anything above £500, the rates are lower than income tax.

The rate of dividend tax on the income tax bracket is 10.75 per cent for basic rate taxpayers, 35.75 per cent for higher rate taxpayers and 39.35 per cent for additional rate taxpayers.

The dividend allowance has been steadily reduced over recent years, making dividend extraction less attractive than it once was. At the same time, employer national insurance contributions (NICs) have become more expensive.

From April 2025, employers pay NICs at a higher rate (now 15 per cent), which significantly increases the cost of taking higher salaries through the UK Pay As You Earn (PAYE) system.

As a result, accountants may recommend that a sole director take a salary roughly around the personal allowance level (£12,570) and then supplement this income with dividends.

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“Most directors land somewhere in between with a modest but consistent salary that covers essentials, with dividends drawn as profits allow,” says Subhashree Sadasivan, director of accounting at Rise Accounting.

A salary around £12,570 allows the director to utilise their tax-free personal allowance while maintaining entitlement to state pension credits and certain benefits. This assumes the director has no additional income from elsewhere which contributes to their personal allowance.

Under this structure, the salary portion generally avoids employee NICs and income tax because it sits within the personal allowance.

The dividend portion then benefits from lower dividend tax rates compared with ordinary income tax rates. This hybrid approach often produces a lower overall tax burden than taking the entire amount as salary.

That said, the calculation is becoming more nuanced in 2026. The rise in employer NICs and ongoing freezes in tax thresholds mean that the advantage of dividends is smaller than it used to be.

What factors affect the choice between salary and dividends?

Other important factors include mortgage borrowing. Banks generally view salary as more stable and predictable than dividends. SME owners planning to apply for mortgages or loans may therefore choose to increase PAYE salary even if it’s slightly less tax-efficient.

“Focusing on tax alone can be short-sighted,” says Stinton. “Taking little to no salary could affect how much money you’re able to borrow for a mortgage,” she adds.

A higher salary also improves maternity pay eligibility. Maternity pay is given as a percentage of salary, not dividends.

For the 2025-26 tax year, the statutory maternity rate is 90 per cent of average weekly earnings for the first six weeks, followed by a flat rate of £184.03 per week (or 90 per cent of average weekly earnings, depending on which is lower) for the remaining 33 weeks.

“Statutory maternity pay is where a low salary creates a real problem,” outlines Sadasivan, adding: “A director taking a £6,500 annual salary would receive significantly less than someone on a higher wage.”

Dividends also come with legal and administrative requirements. Directors must prepare dividend vouchers and board minutes. And unlawful dividends can create problems with the UK tax authorities.

Still, paying yourself in dividends has the advantage that business owners can take the money when it’s best for the business rather than a fixed sum each month, says Sarah Coles, head of personal finance at investment platform AJ Bell. She also says not to worry too much about mortgages as most lenders will consider dividends as part of your income when calculating affordability.

“Most of them will want to see one or two years’ worth of company accounts, to make sure the dividends are affordable for the business,” Coles highlights.

Business owners can also choose to add into their pension contributions through the business rather than through salary.

“Although your personal [pension] contributions will be limited to your salary, the business can pay in up to £60,000,” says Coles. “This is treated as a business expense, which cuts the amount of corporation tax due,” she adds.

What experts agree on is to review the structure annually with an accountant – as tax rules continue to evolve – and figure out tailored strategies to both miminise taxes and protect pensions, maternity leave and other personal finance concerns.

“There is no one-size-fits-all approach,” finishes Stinton.