One of the most frequently asked questions we get from clients is: “Can I do anything else to lower my tax bill this year?”. While there isn’t a ‘one size fits all’ answer, we often find that directors and shareholders have overlooked the benefits of using dividends to replace part of their typical salary earnings to reap the rewards of the reduced rate of tax.
The UK dividend tax system can seem complex but with the right knowledge and understanding, you can navigate it effectively, optimise your income, and reduce that dreaded year-end tax bill.
Understanding dividends
Before delving into dividend tax, it’s crucial to understand what dividends are. Dividends are payments made by companies to their shareholders as a reward for holding their shares. They are distributed from the company’s profits and require a positive retained earnings figure on the balance sheet. Dividends are usually given in the form of cash at regular intervals.
How dividend tax works in the UK
In the UK, the amount of tax you pay on dividends depends on your overall income and which tax band you fall into. The three tax bands for dividends:
- Basic Rate: For individuals whose total income, including dividends, falls within the basic rate tax band of £50,270 across the year, the tax rate on dividends is 8.75%.
- Higher Rate: If your income, including dividends, exceeds the basic rate band but falls within the higher rate band £125,140, the tax rate on any dividends between is 33.75%.
- Additional Rate: For individuals with income, including dividends, above the higher rate band, the tax rate on dividends is 39.35%.
Dividend allowances
The UK government provides individuals with tax-free allowances on dividend income. The dividend allowance is £500 for the tax year 2024/25, meaning that the first £500 of dividend income you receive in a tax year is tax-free, regardless of your other income.
Replacing part of salary income with dividend income
As was alluded to at the beginning, in some situations there can be a huge benefit to using dividend income instead of typical salary with the rate in the basic rate band being 20% if you receive a normal salary, vs the 8.75% we have discussed earlier for dividends.
While there is often a huge saving for your personal tax, it is worth considering the implications of using dividend income instead of a salary on the company & corporation tax.
Unlike a salary, dividends are not a taxable expense and therefore provide no relief against corporation tax.
These basic scenarios set out the same level of income but with varying sources and how they impact personal & corporation tax.
Scenario 1:
£50,270 of income strictly salary would incur:
£7,540 of income tax.
£3,015 of Employee National Insurance
£5,682 of Employer National insurance
Less corporation tax saving (for the salary expense) of £10,630.8 or £13,987 depending on your corporation tax percentage.
Overall net tax position: £5,606 or £2,249 (depending on the corporation tax band)
Scenario 2:
£50,270 whereby £12,570 is Salary income, the remaining £37,700 is issued as dividends, would incur:
£3,255 of income tax
No employee national insurance
£479 of Employer National Insurance
Less corporation tax saving (for the salary expense) of £2,479 or £3,262 depending on your corporation tax percentage.
Overall net tax position: £1,254 or £471 (depending on corporation tax band)
This results in total savings between £4,352 & £1,778 when combining your personal tax and factor in the corporation tax relief on the salary expense.
Final thoughts
Dividends can be a great way of extracting cash from the company tax efficiently and are often partnered with a small salary to optimise your personal tax position while responsibly managing the company’s finances.
If you are interested in learning more about dividends and how they could benefit you, please reach out to one of the team.
Get in touch
If you would like to find out more about how we could support your business, get in touch with our team today or explore our dedicated tax advice service page for more information.