Paying yourself: salary vs dividends (22/78)

An owner who runs an Estonian OÜ can take money out of the company in two main ways: as a salary, or as a dividend from profit. They are taxed in different places and at different times. A salary is a cost of the company and is taxed when it is paid. A dividend is paid from profit, and the company pays income tax on it when it is distributed. This guide explains both routes, shows a worked comparison with round numbers, and lists what to check before you choose.

The two routes in one paragraph

A salary is pay for work, paid through payroll. The company deducts the income tax and the employee contributions from it, and it pays the employer's social tax on top. The salary is a cost, so it reduces the company's profit. A dividend is a share of the profit that the company pays to its shareholders. It is not a cost, and it does not reduce the profit. Instead the company pays income tax on the distribution when the money leaves the company.

How a dividend is taxed: 22/78

Estonia taxes profit when it is distributed, not when it is earned. The income tax on distributions is calculated as 22/78 of the net amount paid out. The formula looks unusual because the tax is calculated on the net amount, not on the gross profit. The result is that the company's total distribution is the net dividend plus the tax.

A worked example with round numbers. Suppose the company pays a net dividend of €7,800 to you. The tax is 22/78 of €7,800, which is €2,200. The company distributes €10,000 in total, of which €7,800 comes to you and €2,200 goes to the state. The tax is paid by the company in the month after the payment, and the distribution is reported in the TSD return.

The company can pay a dividend only from its distributable profit, which in practice is the retained earnings that have not yet been paid out. Before a dividend, check that the retained earnings cover the amount. The rate and the mechanics are set in law and in EMTA's guidance, so check the current pages before you rely on the figure.

How a salary is taxed

A salary is taxed through payroll. Each month the company calculates the gross pay, withholds the income tax and the employee's own contributions, and pays the net amount to you. The company also pays the employer's social tax on the gross pay, which is 33% of the gross salary. That tax is a cost of the company on top of the salary.

The net pay you receive is lower than the gross salary, and the total cost to the company is higher than the gross salary. The exact figures depend on the income tax rate for the year, on any allowances you claim and on the contributions that apply. This guide does not calculate them, because the rates change from year to year, and a calculator is the right tool for a specific case.

A comparison with round numbers

Imagine the company has €10,000 of profit that it wants to pay to you. There are two simple routes.

Route A, dividend. The company distributes €10,000 in total. Your net dividend is €7,800, and the company pays €2,200 of income tax on the distribution. The company's cost is €10,000, and no employer's social tax applies, because a dividend is not a salary.

Route B, salary. The company spends €10,000 in total on your pay. Because the employer's social tax is 33% of the gross salary, the gross salary is about €7,519, which is €10,000 divided by 1.33. The social tax on it is about €2,481. Your net salary is then lower than €7,519, once the income tax and the employee's contributions are deducted.

The comparison shows the main difference. A dividend spends the whole €10,000 on your net and on tax, and a salary spends it on the employer's social tax and on your gross pay. Neither is always better. The result depends on the tax rates in force, on your pension, on any benefits you receive and on what the company needs to keep for its own work.

Things to check before you choose

• Profit and retained earnings. A dividend needs distributable profit. Check the retained earnings in the balance sheet and the profit and loss report for the year.
• Cash. The company needs cash to pay the dividend or the salary and the tax. Look at the cash position before you take the money out.
• Owner loans. Money you have paid for the company, or taken out of it, is an owner loan. It must be shown correctly, and it is not a dividend.
• Timing. A dividend is reported in the month of the payment. The TSD return for that month is due on the 10th of the next month, so plan the cash for the tax.
• Pension and benefits. Pension contributions and the benefits you need from the state depend on the route you choose. Check these before you decide.

A monthly routine

A company that pays both a salary and a dividend must file the TSD return in the months when salaries, board fees or dividends are paid. Sapita shows these months on the calendar and prepares the figures it can, but the decision of how much to pay is yours. This guide is education, not tax advice. For a large or unusual payment, confirm the rule with EMTA or an adviser.

Key terms in this guide

• Dividend: a payment of profit to shareholders.
• Income tax on distributions: the tax charged when profit is paid out.
• Retained earnings: profits not yet paid out.
• Equity: what remains for the owners.
• TSD: the monthly employer return.
• Owner loan: money between the owner and the company.
• Liability: an amount the company owes.
• Balance sheet: the company's position on one date.
• Profit and loss: the result of a period.
• Cash position: the money you have and the money due soon.
• E-MTA: the online service where the TSD is filed.

Sources

• EMTA, income and social taxes, including the tax on distributions: emta.ee
• Income Tax Act (tulumaksuseadus), distributions and salaries, Riigi Teataja: riigiteataja.ee
• Social Tax Act (sotsiaalmaksuseadus), Riigi Teataja: riigiteataja.ee