Dividend allowance

Introduction -the dividend allowance

The annual tax free dividend allowance was brought out in April 2016.

Originally, the annual dividend allowance was £5,000, and this was in place up until the tax year 2017/18.

In 2018/19, the government reduced the allowance to £2,000. The dividend allowance 2020/21 is £2,000 and this is the same for 2021/22.

Before April 2016, the system in place was a tax credit system. Under this system, the dividends that a company chose to pay were 9/10ths of the gross. Therefore, if your company decides to pay you a dividend of £9,000, the gross dividend for tax purposes was £10,000. You would then take the £10,000 into account as part of your overall taxable income.

The change in April 2016 was a radical shake-up in how dividends are taxable. However, it has made the way these are taken into account more simple, and it is much easier for the layman to understand.

Now, before I move on, there are many aspects to paying dividends. These include when should I pay them, the timing of paying them, how much can I pay, the dividend allowance (this article) and illegal dividends.

The annual dividend allowance -how are dividends taxable now?

Let us consider are dividends taxable and how much can you earn before paying tax. It is also useful to consider how much dividend can I pay myself. How are dividends taxable will depend on how much dividends you actually receive and also what your other taxable income is, in the tax year in question. The following sets out how to calculate the tax on your dividends.

  • The first £2,000 is tax-free. This amount is the annual dividend allowance.
  • Any dividends that are above your £2,000 dividend allowance and fall within your basic rate tax band (gross income up to £50,270) are taxable at 7.5%.
  • Dividends that fall in your higher rates tax band (income from £50,270 to £150,000) are taxable at 32.5%
  • Any dividends that fall above the higher rates tax band (income above £150,000) are taxable at the additional rate of 38.1%.

The annual dividend allowance -a common misconception   

The concession that came out in April 2016 was the creation of a tax free dividend allowance. However, this sits within your overall tax bands for taxation purposes.

There is a common misconception that the now £2,000 allowance is tax-free regardless of what you earn. The tax system, however, treats this as part of your income that falls within the basic rate tax bracket (income up to £50,270).

Example   

Let us assume that your gross income in a tax year is just your salary and this is £50,270.  If you also receive a dividend of £2,000, the dividend will push £2,000 of your salary income into the higher rates tax bracket. This £2,000 will be taxable at the higher tax rate on salaries (40%) rather than the basic tax rate (20%). This tax is an additional 20% to pay via the Self Assessment system.

If you are a company owner and you take a salary of £12,570 (currently, the minimum salary that you need to count as a qualifying year for state pension purposes is £9,564). If you also take £60,000 as dividends, your total gross income will be £72,570.

The £12,570 salary is tax-free, and your personal tax allowance covers this.

The £2,000 is tax-free, and your annual dividend allowance covers this.

The other £58,000 worth of dividends are taxable. The first £35,700 falls within the basic rate tax band, and these are taxable at the basic rate tax rate of 7.5%. The result of this is a tax bill of £2,677.50.

The next £22,500 falls within the higher rate tax band, and they are taxable at the higher tax rate of 32.5%. The result here is you incur a tax bill of £7,312.50.

A total tax bill of £2,677.50 + £7,312.50 = £9,990.00.

Note, in this example, how the £2,000 dividend allowance is tax-free, but it takes up £2,000 of your basic rate tax band.

Final thoughts

Therefore, if you receive dividends, you should consider how much can you earn before paying tax. If your company is generating enough profits it is advisable to make sure that you use up your tax free dividend allowance. What’s more, if you earn more than the amount that is taxable at the basic rate (£50,270), you will be paying additional higher rates tax on the amount of income that falls above the basic rates tax line.

Link to Contractor Advice UK group on

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Published On: March 23rd, 2021 / Categories: Dividends, Self-Assessment, Tax Saving Guides / Tags: , /

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