The dividend allowance, which was originally introduced on 6 April 2016, was cut from £5,000 a year to £2,000 from 6 April 2018. The cut is likely to have a significant impact on employees and directors of small businesses who receive both salary and dividend payments.
Family-owned companies, which often distribute dividends at the end of the financial or tax year, experienced the effects of this cut more notably by March/April 2019. Many taxpayers only realized the impact upon filing their tax returns, highlighting the importance of regular tax planning.
How Dividend Income Is Taxed
Tax on dividend income depends on the taxpayer’s total income, which includes earnings, savings, and non-dividend income. The tax rate applied to dividends beyond the £1,000 allowance is based on the individual’s income tax band.
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Dividend Tax Rates for 2023/24
The tax rates for dividend income above the £1,000 allowance are as follows:
- Basic Rate Taxpayers: 8.75%
- Higher Rate Taxpayers: 33.75%
- Additional Rate Taxpayers: 39.35%
Tax Impact of the Dividend Allowance Reduction
The allowance reduction from £2,000 to £1,000 means that taxpayers now pay higher tax on dividend income:
- Basic Rate Taxpayer: Additional tax of £87.50
- Higher Rate Taxpayer: Additional tax of £337.50
- Additional Rate Taxpayer: Additional tax of £393.50
If dividend income spans multiple tax bands, these figures will vary based on income levels.
Example Tax Calculation for 2023/24
Assuming a director receives a £40,000 salary and £12,000 in dividends, the tax breakdown is as follows:
On Salary of £40,000
| Income Component | Amount | Tax Due |
|---|---|---|
| Personal Allowance | £12,570 | £0 |
| Basic Rate (20%) on £27,430 | £27,430 | £5,486 |
On Dividend of £12,000
| Income Component | Amount | Tax Due |
|---|---|---|
| Dividend Allowance | £1,000 | £0 |
| Basic Rate (8.75%) | £9,570 | £836.63 |
| Higher Rate (33.75%) | £1,430 | £482.63 |
Total Tax Due for the Year = £6,805.26
Reporting Dividend Income to HMRC
For those not registered for self-assessment:
- Dividend income up to £1,000 generally requires no reporting.
- Dividend income between £1,000 and £10,000 can be reported through an adjustment to the taxpayer’s PAYE tax code or a self-assessment return.
- Income over £10,000 must be reported via self-assessment, with tax usually due by January 31 following the tax year in question.
Family Businesses and Dividend Planning
Family-owned businesses, where dividends may be shared among multiple family members, are particularly affected by the allowance reduction. A pre-dividend review with an accountant can help ensure that dividends are tax-efficient and legally compliant.
Careful dividend planning, especially in family-owned companies, is key to optimizing the benefits while remaining within tax regulations.
