As a limited company owner, you’ll most likely pay yourself using a combination of salary and dividends. While it’s often the most tax-efficient way to withdraw money, be careful! Dividends have different tax rules compared to a normal salary. Don’t worry – we’re going to walk through what they mean for your business and how to navigate them strategically. Let’s dive into the world of dividends!
What are dividends?
Dividends are a portion of your company’s profits attributable to shareholders. They can only be paid out of retained earnings. In other words, from the profit left after you’ve paid your company’s taxes, VAT and expenses.
Normally, any shareholders in your company will receive a dividend payment. How much they’re paid will depend on the number and type of shares they have.
They can be a great way to manage your income:
- Dividends have a much lower tax rate compared to a PAYE salary.
- They aren’t subject to National Insurance.
Ultimately, dividends are far more tax-efficient than taking a large salary paycheck!
HMRC has introduced big changes to dividend taxation.
The most significant change is to your dividend allowance. This is the total amount of tax-free dividends you can receive in a year.
- The dividend allowance for 2023/24 has reduced from £2,000 to £1,000.
- You can receive dividends up to £1,000 without having to pay tax on them.
- In 2024/25, the allowance will be reduced to £500.
The dividend allowance is separate from your personal tax allowance. You can still use both, and there will be no dividend taxation up to the allowance threshold (regardless of whether you receive other income).
Dividend tax rates for 2023/24
For the 2023/24 tax year, dividend tax rates over £1,000 have stayed the same (as with rates over £500 for 2024/25). Be aware the tax is based on marginal bands, meaning you might pay various rates of tax.
Let’s break down the tax rates and codes you need to know:
- Personal allowance – You won’t have to pay any tax on the first £12,570 of your income (whether it’s from salaries, dividends or other sources).
- (i) Base rate – You’ll pay 8.75% tax on dividend income between £12,571 – £50,270. Most limited company owners fall into this category.
- (ii) Higher rate – You’ll pay 33.75% tax on dividend income between £50,271 – £125,140. If you’re in this category, be wary about how dividends impact your tax liability.
- (iii) Additional rate – You’ll pay 39.35% tax on dividend income above £125,140. In this category, you need to be very strategic about tax planning to minimise your liability at this highest rate of dividend tax.
Due to the lower dividend allowance for 2023/24 and 2024/25, more of your income from dividends will be taxed. Before taking out dividends, consider if there’s a more tax-friendly alternative to pay yourself.
How to work out your dividend tax
The amount of tax to pay once you exceed the dividend allowance threshold depends on your income tax bracket. Once you know this, calculating how much you need to pay on dividends is quite straightforward.
Here’s how to work it out, step by step:
- Review your total income. Add up all your sources of income: dividends, salary, rent, etc. This total figure is your tax bracket.
- Factor in your personal allowance. Deduct your £12,570 personal allowance from your overall income (you won’t have to pay dividend tax if your total income is lower than this).
- Calculate your dividend income. The remaining figure is your dividend income.
- Use your dividend allowance. Remember: you don’t have to pay tax on the first £1,000 of dividend income for 2023/24, or the first £500 for 2024/25.
- Pay tax on the remaining dividends. Dividends that exceed the tax-free allowance will need the correct tax rate applied (which you can find above).
- Work out your tax liability. Calculate how much you need to pay in dividend tax by adding together the taxes from each band. Simple!
How and when to pay dividends
As long as you follow the tax rules, you can pay out dividends as often as you like. Most companies pay them out every quarter, but you can pay them bi-annually or yearly if you prefer.
Declaring dividends requires a directors’ meeting.
Even if you’re the only director in your business, you’ll need to call a directors’ meeting to declare dividends and – most importantly – record this in the minutes.
You’ll also need to provide a dividend voucher for each dividend declared, which includes the following:
- Date
- Name of your business
- Shareholder name(s)
- Dividend amount
We help all of our limited companies comply with this paperwork, producing minutes and dividend vouchers at the year-end accounts approval stage.
Take a strategic approach to withdrawing profits.
Although the changes to the tax-free dividend allowance seem small, you may have to pay out significantly more in tax if you depend heavily on dividend income. To avoid a heftier tax liability, you’ll need to be strategic about how you withdraw money from your business.
The best thing to do is to review your income plan with your accountant and look at more tax-efficient strategies to make up your income.
Feel confident you’re not paying more tax than you need.
Whether you want help decreasing your tax liability, working out tax rates or dealing with the necessary paperwork, it all starts with a chat. Book a call with the DNA team and we’ll help you navigate dividends with peace of mind.
