For small business owners dividends have traditionally been seen as the preferable way to take money out of a business. This was because the tax rates on dividends were lower than if the money had been taken as salary. From April 2018 the rules have changed making this method less attractive as the government aimed to reduce the tax difference between the self-employed and those working through a company, although with careful planning it can still be the more tax effective option.
From April 2018 you can earn up to £2,000 in dividends before you pay any tax, this has reduced dramatically from the £5,000 you could earn tax free previously.
If you earn more than £2,000 in dividends you will need to pay tax based on your tax band (the band that you pay income tax on). The rates are:
Basic rate - 7.5%
Higher rate - 32.5%
Additional rate - 38.1%
For example if you are already higher rate tax payer and you earn £5,000 in dividends you will pay £975 in Dividend tax (£5,000 less the £2,000 tax free allowance is £3,000. £3,000 at 32.5% gives you £975 in tax to pay)
While the changes to the dividend tax free allowance will increase the tax paid the rates charged are still below those charged on other income from things like interest, salaries and pensions (where tax rates are 20%, 40% and 45%). Please contact us at 2 Sisters Accounting if you would like some advice on the most tax efficient way to pay yourself or others from your business.
If you earn less than £2,000 in dividends you do not need to do anything or inform HMRC as this makes up your tax free allowance. Between £2,000 and £10,000 you will need to tell HMRC so that either they can adjust your tax code or ask you to complete a self-assessment tax return. If you earn over £10,000 you will need to complete a self-assessment tax return. 2 Sisters Accounting can help with completing tax returns and any other tax questions you may have.