What the UK dividend tax rate increase means for your small business

Dividends are a great way to receive a regular income from your investments. However, as with any income you earn, you may have to pay tax. In the Autumn Budget, the government announced that the tax on dividends will increase by 1.25%  from 6 April 2022.

Who will be affected by the dividend tax increase?

You can expect to pay more tax from April next year if:

• You’re a director/shareholder who opted for a high dividend and low salary
• You hold stocks and shares outside your ISA and have exceeded your dividend tax allowance
• If you’re a contractor or freelancer working through your own limited company and receive dividends

See also: How does a limited company work in the UK?

How much tax will you pay in 2022?

Under the new dividend tax changes, basic rate taxpayers will now pay 8.75% tax on dividends, up from 7.5%. Higher rate taxpayers will pay 33.75%, up from 32.5%. Additional rate taxpayers will see their dividend tax rate rise to 39.35% from 38.1%.

How do I work out how much dividend tax to pay?

The first £2,000 you receive will remain tax-free – also known as the tax-free dividend allowance. You won’t pay tax on shares held in stocks and shares in an Individual Savings Account (ISA), junior ISA, lifetime ISA or a self-invested pension plan (SIPP).

For example, if you received a dividend income of £55,000 and an income of £8,000, your tax bill will be calculated as follows:

• The personal allowance for 2021/22 is £12,570 of which £8,000 has been used against your salary, leaving £4,570 available. This covers the next £4,570 of dividend income, which is received tax-free.
• The first £2,000 of dividends is also tax free but this £2,000 is also part of your initial basic tax band of £37,700
• The dividend amount to be taxed is £55,000 - £4,570 - £2,000 = £48,430
• Basic rate tax is calculated at 7.5% for the first £35,700 (£37,700 - £2,000) = £2,677.50
• Balance of the dividend being £12,730 (£48,430 - £35,700) is taxed at 32.5% = £4,137.25
• Total tax owing is £2,677.50 + £4,137.25 = £6,814.75

When is dividend tax payable?

If your dividend earnings are less than £2,000, you don’t need to do anything and there’s no need to inform HMRC.

If you earn between £2,000 and £10,000, you’ll need to inform HMRC. Your tax due can be paid in two ways: You can ask HMRC to adjust the code so that the tax is taken from your salary or pension, or you can submit a Self Assessment tax return.

If you earn more than £10,000 in dividends, you will need to complete a tax return.

See also: A complete guide to understanding the UK tax system

Ways to reduce the impact of the dividend tax increase

There are some things you can do to help minimise the impact of the dividend tax hike.

Increase your ISA investment

The dividends you receive on investments held in an ISA are tax-free. Therefore, you can reduce your dividend tax bill by investing the maximum amount into your ISA. This is currently set at £20,000 per year.

Make pension contributions

Pension contributions benefit from tax relief at the marginal rate of income tax, which can help increase your savings by 20%-45%. You can contribute up to 100% of your earnings to your pension each year, or up to the annual allowance of £40,000.

Invest with your partner

If you’re married or in a civil partnership, you might be able to reduce your dividend tax bill by investing as a couple by spreading your taxable portfolio between you and your partner. This will allow you to make the most of your dividend allowance as well as the basic rate tax band.

We offer specialist outsourced bookkeeping, accounting and financial management to businesses, private individuals and contractors in the UK. Our accountants listen and learn about your particular circumstances to enable us to design an accounting solution tailored to your specific needs. Get in touch with us at accounting@sableinternational.com or call +44 (0) 20 7759 7553.