When business partners who actively work in their company consider extra compensation, they usually have two options: receiving a salary bonus or taking dividends. The choice isn’t always straightforward, as each option has different tax implications and costs. Understanding these differences can help determine the most beneficial route.
A salary bonus is treated as regular income and is subject to personal income tax (IRPF) at the partner’s marginal rate. The advantage of this approach is that the company can deduct the bonus as a business expense, which reduces its taxable profit and lowers the Corporation Tax (IS). For small companies, this means an effective 24% deduction. However, a key downside is that a salary bonus might also increase Social Security contributions, making it a more expensive option in some cases.
On the other hand, dividends are taxed under the savings income bracket at lower rates, ranging from 19% to 30%. This makes them an attractive option for partners who are in higher income brackets. Unlike a salary, dividends are not subject to Social Security contributions, which reduces overall costs. However, dividends do not count as a deductible expense for the company, meaning that the business still pays full Corporate Tax on the distributed profits.
So, which option is better? It largely depends on the individual’s total earnings. If a partner’s marginal income tax rate is 37% or lower, a salary bonus may be the best choice because the company’s tax savings offset the personal tax burden. However, if the marginal rate is 45% or higher, dividends are often the smarter move, as they result in a lower overall tax bill and avoid additional Social Security expenses.
To illustrate the impact of these options, let’s consider a partner who wants to take home an additional €20,000 in net income. If their marginal tax rate is 37%, the company needs to pay €31,746 in gross salary to cover the taxes and deductions. However, with the Corporation Tax savings, the net cost for the company is only €4,127. In contrast, if the partner opts for dividends, the gross amount required is just €25,165, but the company receives no tax deduction, making the total cost €5,165. For someone in a 45% tax bracket, the gap widens, making dividends an even more attractive option.
Ultimately, the best decision depends on personal income levels, tax brackets, and the company’s financial situation. Those in lower tax brackets may benefit from a salary bonus, while high earners typically find dividends to be the more tax-efficient choice. Running the numbers and consulting with a tax advisor can help ensure the most advantageous approach.
