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Tax efficiency: Bonus or Dividends?

A common problem that contractors can have is deciding what is the most tax efficient way to deal with end of the year profits in the company account. Here we’ll have a quick run through two of the main options out there: Bonus or dividends.trans Tax efficiency: Bonus or Dividends?

Let’s consider the following example:

  • There is a €100,000 pre-tax profit sitting in your company account at year end.
  • You are operating under a private limited company and you’re an Irish tax resident company and you’ve also availed of all your personal tax credits (i.e. PAYE).
  • You have exceeded the lower rate of tax (20%) in your annual salary.
  • You are the sole shareholder of the company.

So your company has done well this year, and there are €100,000 pre-tax profits sitting in your account (We know €100,000 may be slightly fantastical, but it makes the maths easier.) But which option should you take?

So, either a “nice big ol’ pat on the back” bonus for yourself or issue yourself dividends. When you’re the sole proprietor of the company, they’re essentially the same thing. All that really matters to you is how to keep as much of that €100k when transferring it from company account to your back pocket. Let’s consider the numbers.

While there of course individual issues, a general statement can be made that the effective rate of tax on dividends is just over 60% (60.625% to be precise) and the effective rate for a bonus is around 55%. Instead of going through the maths in blog form, we’ll do it table style – giving you a quick and simple account to explain it. The 2nd column illustrates what you get if you pay yourself a bonus and the 3rd column is if you pay yourself dividends.

Company Account

Bonus Dividends
Your company’s pre-tax profits: €100,000 €100,000
Less your bonus: (€100,000) (€0)
Taxable profits: (€0) €100,000
Corporation Tax @ 12.5%: (€0) (€12,500)
After tax: €0 €87,500
Pay dividend: (€0) (€87,500)
Remaining balance: €0 €0

Personal account

Total income €100,000 €87,500
Income tax on bonus @ 55%* (€55,000) (€0)
Income tax on dividends** @ 55% (€0) (€48,125)
Net income €45,000 €39,375

*Income tax is a culmination of taxable income at 41% (upper income tax band) + 10% (PSRI) + 4% (USC)
**Company is eligible for dividends withholding tax exemption in this case as an Irish tax resident company

When looking at it this way it’s evident to see the logical option is to pay yourself a nice big fat bonus for the year end and enjoy an extra €5,625. But while this is generally the case, it isn’t always. In order to make this decision, the company’s tax liabilities would have to be assessed on a personal case basis something we cannot do in a blog piece. However, we’re nice and like helping our customers. The next step is for you to get in touch.

We’ll have more pieces like this coming out in the coming weeks like alternatives to the above options and other methods of tax efficient spending. Be sure to subscribe to the blog not to miss out on these!

Have you experienced any problems when trying to operate a company in a tax efficient way? Leave a comment or get in touch, we want to hear about them.

Disclaimer: The above does not constitute legal or accounting tax advice. While we have taken care to present as informed a piece as possible the above is a generalised statement and tax liabilities are assessed on a case by case basis. Neither Bullet nor the author of this piece will reimburse companies or individual for losses incurred due to misuse of information found in this blog. Ultimately any action taken based on the information presented above is the responsibility of the reader.

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  • http://www.facebook.com/people/James-OSullivan/663077976 James O’Sullivan

    Wiki need to update there figures from 20% to 55% pretty quick because if you google this its a little misleading! ;) Nice simple explanation – we all hoped it was not 55% however – ouch!

  • http://www.facebook.com/mehargstuart Stuart Meharg

    While bonus/salary may be more tax efficient than paying a dividend, they are both very tax inefficient methods of extracting profits. One option for dealing with excess profits in the circumstances described (where there is no obvious benefit of re-investing the profits back into the company) is a pension contribution.

    The marginal rate of tax for a company director is 52% (41% income tax; 4% PRSI; 7% USC).

    The company would be obliged to deduct dividend withholding tax (at 20%) from a dividend paid to an Irish resident individual, but this can be offset by the individual against the income tax bill.

    As the author rightfully points out each case must be examined individually, however, I do think there is a danger that this article over simplifies the options available.