Tax-free dividend allowance and contractor dividend tax

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Introduction 

The annual tax-free dividend allowance (DA) was first introduced in the UK in April 2016. However, what’s the annual dividend allowance 2024/25, and how does it work for UK contracting professionals? The dividend tax allowance is available to all UK individuals. What’s more, you can take this allowance into account when calculating your UK contractor dividend tax. Furthermore, the introduction of the tax-free UK allowance changed how you pay tax on UK dividends. Consequently, this makes the way an IT professional pays tax on their contractor dividends simpler to follow. Also, the dividend tax system in the UK is now much easier to understand.

As a UK contractor running your own company, you’ll take income from your company every week or every month. When taking UK company dividends, contractor options include a combined dividend and director salary income as part of your take-home pay. Therefore, as part of a contractor salary and dividends strategy, you can utilise your limited company tax-free allowance (UK) for dividends each year. Also, you can take further dividends and a salary from your UK company. As a result, your dividends above the DA are taxable, and your contractor’s tax rate or rates will depend on your overall taxable income. Your personal tax liability on any taxable income, including dividends, is payable to HMRC via your Self Assessment tax return each year.

This guide will research how the DA works and examine the history of dividend personal tax allowances (UK). We’ll also research the tax on dividends (UK), dividend rates of tax and how you pay the dividend taxes (UK) as a contractor. Furthermore, we’ll investigate the tax-free dividend allowance 2024/25 and the HMRC dividend tax rates 2024/25 (UK).

Initial thoughts on the tax-free dividend allowance 2024/25 

Tax allowances

In the UK, the government sets allowances each year for certain types of income. First, there’s an annual personal allowance (PA) for your overall UK income. Next, there’s an annual savings allowance for your savings income (interest). Furthermore, there’s a tax-free personal annual allowance for your dividend income. This is known as the UK tax-free dividend allowance.

As an individual, you may have one or more income sources which fall above the allowance available for that type of income(s). As a result, this income source(s) is taxable through your personal tax return at the end of the tax year. Once you file your tax return, you’ll have a tax bill due to HM Revenue & Customs (HMRC). As a result, you can pay the tax to them by the deadline.

What should you consider when taking dividends from a company?

As a limited company contractor, when you take contractor dividends, you may ask, how much dividend can I take tax-free? Moreover, you may wonder how much you’ll pay in contractor dividend tax. Indeed, these are key thoughts when UK contracting and running your own company. Knowing what you can earn free of tax and what income is taxable will help you plan for the future to be tax-efficient. If you have a good contractor accountant, they’ll help guide you. As part of this, they’ll show you how to be tax-efficient when you take income from your company. Therefore, this guide will further investigate tax efficiency as a contractor. In addition, let’s consider how dividends tax works in the UK.

Common questions on the tax-free dividend allowance

When contractors and other individuals begin to receive dividends, they may have questions about this. Indeed, that’ll include questions on the UK dividend tax-free allowance and the tax on UK dividends. Therefore, some examples of such questions from first-time contractors and limited company owners will include:

  • When did dividend tax start?
  • What is a tax-free allowance?
  • Are dividends taxable?
  • What is the annual dividend allowance?
  • How does tax-free allowance work?
  • How much dividend is tax-free (UK)?
  • When do you lose tax-free allowance?
  • How much is dividend tax?

In this guide, we’ll examine the above questions and research how the dividend system works in the UK. We’ll also research how the annual tax-free dividend allowance functions against your UK income. Furthermore, we’ll learn the tax rate on dividends 2024/25.

Other dividend guides 

Introduction to other guides

Before we move on, there are several aspects to consider when you pay contractor dividends from your UK limited company. Indeed, we’ve written about all these dividend subjects in depth on this contractor’s website.

In addition, we’ve many other guides on this site which cover all sorts of key areas of UK contracting. These look at how to work effectively and tax efficiently as a contractor in the UK. What’s more, they cover company set-up, salaries, expenses, taxes, tax tips and many other contractor-related areas.

Dividend guides -what should you consider when taking dividends from your company?

Now, back to our UK dividend guides. Therefore, the guides on our website, which cover contractor dividends explained include:

  • When should I pay dividends? The guide covers when you should take dividends from your company and explains when and how often contractors usually take dividends from their UK companies.
  • The timing of paying dividends. This guide covers how to time your payments regarding UK tax years. Moreover, it explains how to `declare’ dividends for tax purposes and then pay them from your company later. This can be key regarding end-of-year tax planning in the UK. 
  • How much dividend can I pay? The guide covers the profit in your company after company tax. If you don’t have cash tied up in investments or other assets, all the post-tax profits are usually available to pay as dividends. What’s more, this guide explains how you can work out the profit available in your company for dividends. 
  • The limited company tax-free dividend allowance (this guide).
  • Illegal dividends. This guide covers what you should consider if you overdraw dividends from your business. This can occur in several scenarios, and it’s key you realise when this is the case. In this guide, we explain what action to take if you overdraw dividends so you can correct this in the future.

Therefore, please read these other guides at your leisure. They’ll help give you a better insight into how UK dividends work. They cover all the aspects of dividends you should consider as a UK contractor, putting you in good stead in the future.

UK tax-free dividend allowance -recent history

UK dividend tax allowance history

When we look at the personal dividend allowance history, since it was introduced, it’s gradually reduced over recent years. In the 2016/17 tax year, the annual dividend tax-free allowance was £5,000. In addition, this was kept in place until 2017/18. Furthermore, in 2018/19, the UK government reduced the tax-free dividend allowance (UK) to £2,000, which remained at the same level from 2019/20 to 2022/23. The dividend tax allowance in 2023/24 was £1,000, and from 6 April 2024 (2024/25), the DA is reduced to £500.

To sum up, the recent history of the UK DA has been:

Dividend
Tax year allowance
2016/17 5,000.00
2017/18 5,000.00
2018/19 2,000.00
2019/20 2,000.00
2020/21 2,000.00
2021/22 2,000.00
2022/23 2,000.00
2023/24 1,000.00
2024/25 500.00

In the future, we must wait and see what the UK government will do with the DA. For example, they may decrease the DA further. Indeed, they may decide to increase the tax-free UK dividend allowance. On the other hand, they may choose to abolish it entirely at some point in the future. Therefore, we’ll see what happens regarding this as time goes on.

UK dividend tax rate history 

Before April 2016, the dividend system in place was a tax credit system. Therefore, up to 5 April 2016, you’d receive a contractor dividend tax credit when you paid a dividend. Indeed, under this system, the company’s dividends were treated as 9/10ths of the gross. Therefore, 9/10ths of the amount paid was the net dividend, and 1/10th was the tax credit. As a result, if your limited company decided to pay you £9,000, the gross dividend for tax purposes was £10,000. As a result, you’d then take the £10,000 into account as part of your overall taxable income in your Self Assessment tax return. In conclusion, dividend tax credits no longer apply for dividends received after 6th April 2016. Besides the introduction of the new dividend allowance on 6 April 2016, the following dividend tax rates came in:

Basic rate tax 7.50%
Higher rate tax 32.50%
Additional rate tax 38.10%

The above historic dividend tax rates were in place until 5 April 2022. When we consider how dividends are taxed, from 6 April 2022, the UK tax rates increased to:

Basic rate tax 8.75%
Higher rate tax 33.75%
Additional rate tax 39.35%

The above shows that the recent historical dividend tax rates were the same for several years. That was until the change which occurred in 2022/23. The rates from 2022/23 are now still in place as the UK dividend tax rates 2024/25.

The change in April 2016 was a radical shake-up in how dividends are taxed. Indeed, it was a surprise for limited company contractors and other UK companies. What’s more, it’s simplified how these are considered taxable income. Therefore, the taxation of dividends is now much easier for the layman to understand. 

The tax-free dividend allowance 2024/25 & dividend tax explained 

UK dividend tax rates 

Now, let’s consider how your dividends are taxable in the UK. Moreover, let’s look at how much you can earn as income before paying taxes. Furthermore, let’s look at the UK dividend tax rate and how much you’ll pay. Besides your DA, dividends above this level will incur the basic dividend rate of income tax. In addition, if you earn above £50,270, you’ll pay dividend higher rate tax.

Knowing how much dividend you can pay yourself from your contractor limited company at any moment is helpful. Therefore, in 2024/25, the amounts are £12,570 personal allowance (PA) and £5000 DA, respectively. What’s more, the £12,570 appears in your tax code and is applied to your salary on an ongoing basis.

It’s also key to remember that the limited company dividend tax (UK) you pay depends on how much dividends your company pays you. What’s more, when you run your company, you don’t have to draw out all the company profits as dividends. This is a benefit when you’ve your own company because it’s your choice what to take as dividends. Many who run their own company and have the profits to do so will take taxable income from their company to use up their basic rate (BR) tax band. In summary, your UK dividends will form part of your taxable income in the tax year.

Limited company dividend tax rate (UK) -how do you calculate contractor dividend tax in the UK?

The below describes how the dividend tax rates (UK) apply to your income. Indeed, it shows how to calculate the income tax rate for contractors, depending on your overall total income. Therefore, the points to take note of and contractor tax rates, which apply to your contractor dividends, are:

  • Dividends are subject to tax only, while salaries are subject to Income Tax and National Insurance. 
  • How much dividend is tax-free? The personal dividend allowance 2024/25 is now £500. However, as mentioned earlier, the new dividend allowance of £500 may change again in future tax years.
  • Any dividends falling within BR tax are taxable at a contractor tax rate of 8.75%. Basic rate taxpayers and HR taxpayers have a BR tax band. This covers taxable income up to £50,270 pa in 2024/25, and this will likely increase in the future.
  • Dividends falling in your higher rate (HR) tax band (income from £50,270 to £125.140) are taxable at 33.75% in 2024/25. When your overall taxable income exceeds £100K, you’ll start to lose your PA of £12,570. Basically, you’ll lose your PA by £1 for each extra £2 you earn in net adjusted income over £100K. This means once your net adjusted income reaches £125,140, your PA is £0. In addition, earning over £100K means up to £12,570 of your previously tax-free income is now taxable at HR.
  • Any dividends that fall above the HR tax band (income above £125,140) are subject to extra dividend tax. As a result, additional rate taxpayers pay the top rate of tax. Therefore, dividend income above this level is subject to the additional dividend tax rate of 39.35%.

How does the tax-free dividend allowance 2024/25 work?

The concession that came out in April 2016 was the creation of a new annual tax-free UK dividend allowance. The annual dividend allowance lets a person in the UK earn dividends up to this amount before paying the dividend tax. Therefore, the £500 allowance in 2024/25 is tax-free regardless of your overall earnings.

Your UK personal tax allowance is £12,570 in 2024/25. The PA appears in your PAYE tax code each tax year. In addition, any benefits in kind and other tax code adjustments are included in your tax code. As a result, your overall tax code is applied to any UK employment earnings. What’s more, if you don’t have any benefits, the PA is the amount you can earn as taxable income annually before you pay Income Tax.

The UK dividend tax allowance works similarly to your PA. Under this system, you can earn £500 in dividends on an annual basis before you pay tax. Therefore, when you run your own company, it’s key to ensure you take at least £500 in dividends each year. When you do this, you’ll use your annual dividend allowance.

Likewise, there’s a UK tax-free allowance for any interest income on personal bank accounts. Please note that this doesn’t include interest earned on ISAs, as this is tax-free. Depending on your overall tax rate, the interest allowances mean a certain amount of non-ISA bank interest is tax-free each year.

To summarise, you can earn up to £12,570 in your overall taxable income on an annual basis before you pay Income Tax. In addition, you can earn up to £500 in dividends in 2024/25 before paying dividend tax.

Examples of contractor tax bills & the UK DA 

First example

Bob is an IT contractor with his own UK company. He provides IT consultancy services to his clients in the UK. Bob’s gross income during the 2024/25 tax year is just his salary, which is £50,270. Furthermore, Bob receives a dividend payment from his company of £500. As a result, Bob’s total income in the 2024/25 tax year is £50,770. Therefore, we’ll work out Bob’s tax on the amount of his salary that falls above his PA:

Type of earnings Earnings Tax-free Taxable Taxable BR Taxable HR Tax rate Tax
Salary 50,270 12,570 37,700 37,700 20% 7,540.00
Dividend 500 500 0 0 0.00
7,540.00

As a result, the total tax bill for 2024/25 is £7,540.00. What’s more, Bob will pay this via his SA tax return after the end of the tax year. In addition, the tax is due by 31 January after the end of the tax year. Therefore, for the tax year ending 5 April 2024, the due date is 31 January 2025.

Second example

In this second limited company dividend tax example, Jim is a UK contractor with his own UK company. What’s more, he provides management consultancy services to his clients in the UK. Jim takes a salary of £12,570 from his company in 2024/25. At this level, it will qualify for state pension purposes. Also, Jim takes £60,000 as contractor dividends from his business. As a result, his total gross income in 2024/25 is £72,570. Therefore, we’ll calculate Jim’s tax on the amount of dividends which fall above his PA:

Type of earnings Earnings Tax-free Taxable Taxable BR Taxable HR Tax rate Tax
Salary 12,570 12,570
Dividend 60,000 500 59,500 37,200 8.75% 3,255.00
22,300 33.75% 7,526.25
10,781.25

As a result, there is limited company dividend tax payable of £10,781.25. Jim’s total contractor dividend tax bill for the 2024/25 tax year is the amount he’ll pay via his SA tax return.

Summary of the above examples

The above are two simple examples of how dividend tax works for UK contractors. However, some contractors have different levels of salary and dividends. As a result, the tax band and tax rates interact, as we described previously. Indeed, any part of someone’s PA that is spare, after they include their salary and any other income, can be set against their dividends. In addition, each tax year, you have your personal DA, which you can use to cover tax-free dividends.

In conclusion, the Income Tax on your dividends and other taxable income is your total income tax bill. This amount and any Capital Gains Tax are your total tax bill. The total bill is payable to HMRC every year before the deadline. What’s more, you’ll pay this tax to HMRC after you file your SA tax return. Indeed, when you have an accountant who looks after you, they’ll complete and file your tax return each year. In addition, they’ll advise you on what tax to pay to HMRC and let you know when the tax payments are due.

Final thoughts

If you receive dividends through your contracting company, you should consider how much you can take as dividends before paying dividend tax. Indeed, when your company makes enough profits, it’s advisable and tax-efficient to draw enough dividends to use up your £500 UK tax-free dividend allowance 2024/25. In addition, you can take more dividends over and above your UK dividend tax allowance. However, when you do this, you should ensure you save funds personally for your SA tax bill. Moreover, saving for this tax in a personal savings account is a good idea. This way, the savings are kept separate from your normal company funds.

If you earn more than the amount taxable at BR (£50,270), your £500 annual dividend allowance (£1,000 in 2023/24) will still be tax-free. However, you’ll be paying HR tax on income that falls above the BR tax line. If unsure, you can always ask your accountant to help work out your taxes. Once again, when you’re a contractor, you should save for your personal tax as you go along. Indeed, you can save in a safe place, such as an individual savings account. Then, when the payment becomes due, you pay this to HMRC before the deadline.

As a final note, we hope you enjoyed this guide on the UK DA. As mentioned, please review the other dividend guides on this contractor’s website for more details. These will give you a better view of how dividends work in the UK. Indeed, it’s important to know this when you have your own business.

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Published On: April 6th, 2024 / Categories: Dividends, Self-Assessment, Tax Saving Guides /

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