Dividend allowance

Introduction

The annual tax-free dividend allowance was introduced in the UK back 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 in the tax year 2021/22 is £2,000 and this is the same for 2022/23.

Before April 2016, the dividend system that was 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 decided 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 we move on, there are many aspects to paying dividends. These include when should I pay them, the timing of paying themhow much can I pay, the dividend allowance (this article) and illegal dividends.

The annual dividend allowance –the dividend tax rates

Let us consider how dividends are taxable and how much can you earn before you start paying tax. It is also useful to know how much dividend you can pay yourself from your company at any one time. How dividends are 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 tax-free allowance each tax year.
  • 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 8.75%.
  • Dividends that fall in your higher rates tax band (income from £50,270 to £150,000) are taxable at 33.75%. Please note, when your overall taxable income exceeds £100K you will start to lose your personal allowance of £12,570 by £1 for each extra £2 that you earn. What this means is up to £12,570 of your income that was previously ta- free is now taxable at basic rate while up to £12,570 of your income that was previously taxable at basic rate is now taxable at the higher rate.
  • Any dividends that fall above the higher rates tax band (income above £150,000) are taxable at the additional rate of 39.35%.

A common misconception   

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

There is a common misconception that the £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 band (income up to £50,270).

Therefore, the way that this actually works, is:

  • If you are a basic rate tax payer and your dividends do not take you into the higher rates tax bracket (income above £50,270), the first £2,000 of those dividends will be tax free.

*  If you receive dividends of £2,000 and your other taxable income is at least £2,000 less than £50,270, all of the dividends will be tax free. However, if your dividend will take your total taxable income up to £50,270 and beyond this, part of the £2,000 will be tax free and part of it will result in extra tax at 20% (see below)

  • If your other taxable income is above £50,270 (higher rate tax) or £150,000 (additional rate tax) and you receive dividends of £2,000, this will push £2,000 of your other income (salary etc) into the next higher bracket. This will result in additional tax payable on the £2,000 of 20% (£400) for higher rate tax payers and 25% (£500) for additional rate taxpayers, payable via their Self-Assessment Tax Return.

Examples

Example #1

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 payment of £2,000, the dividend will push £2,000 of your salary income into the higher rates tax bracket. This £2,000 will then be taxable at the higher tax rate on salaries (40%) rather than the basic tax rate (20%). This is an additional 20% (£400) tax will be to pay via the Self-Assessment system.

Example #2

You have a small business and 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 £9,876). 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 £2,000 worth of dividends.

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 8.75%. The result of this is a tax bill of £3,123.75.

The next £22,500 falls within the higher rate tax band, and they are taxable at the higher tax rate of 33.75%. The result here is you incur a tax bill of £7,593.75.

Therefore, the total tax due will be £3,123.75 + £7,593.75 = £10,717.50.

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

If you receive dividends, you should consider how much can you earn before you start paying tax. If your company is generating enough profits, it is advisable and tax-efficient 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 and the £2,000 tax-free dividend allowance, or part of this, will no longer be tax-free.

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

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