What is Dividend Tax?
Dividend tax is payable at different rates on income from company dividends. Understanding how tax effects your dividend income is the best way to minimise your dividend tax bill.
The income tax rates are different to the rates at which you pay dividend tax and they decide which rates of dividend tax apply to you.
Tax on dividend income can be important in different ways depending on if you are a stock market investor or a limited company director with a shareholding in your own company.
Any dividend income from shares held in a tax free ISA is not liable to tax.
What is the tax free dividend allowance?
The tax free dividend allowance is available to everyone and means you don’t need to pay tax on all of your dividend income.
Your dividend allowance is added to the personal allowance with both being deducted from your income.
The total income you will be taxed on is the figure left over after your dividend and personal allowances have been deducted.
If your total earnings including any dividends are below the personal allowance no income tax will be payable.
Tax year
6 April 2024 to 5 April 2025: £500 dividend allowance.
6 April 2023 to 5 April 2024: £1,000 dividend allowance.
6 April 2022 to 5 April 2023: £2,000 dividend allowance.
6 April 2021 to 5 April 2022: £2,000 dividend allowance.
It is not possible to carry forward the tax free dividend allowance into a future tax year and the allowance can sometimes be changed in the governments budget so it’s always best to check to see if it’s gone up or down each tax year.
What is the dividend tax rate?
The dividend tax rate is the percentage of tax you will pay on your dividend income. There is more than one dividend tax rate and the rates increase depending on which tax band your income is taxed at.
If your income spans more than one tax band you may pay dividend tax at more than one rate.
Dividend tax rates
Tax band
Basic rate tax: 8.75% dividend tax rate.
Higher rate tax: 33.75% dividend tax rate.
Additional rate tax: 39.35% dividend tax rate.
Dividend tax rate example
You get £4,250 in dividends and earn £36,750 in wages in the 2022 to 2023 tax year.
This gives you a total income of £41,000.
You have a Personal Allowance of £12,570. Take this off your total income to leave a taxable income of £28,430.
This is in the basic rate tax band, so you would pay:
- 20% tax on £24,180 of wages.
- no tax on £2,000 (22/23 tax year allowance) of dividends, because of the dividend allowance.
- 8.75% tax on £2,250 of dividends.
How do I pay dividend tax?
There are typically three scenarios when it comes to paying tax on your dividend income.
Dividend income of £500 or under
Your dividend income should not be taxed because it is under the dividend tax free allowance. You do not need to tell HMRC or take any further action for tax purposes.
Dividend income of between £501 and £10,000
Income for dividends that are in the £2001 to £10,000 bracket need to be declared to HMRC.
HMRC give the following guidelines for declaring your dividend income:
- Phone HMRC on 0300 200 3300 to allow for your tax code to be adjusted so the dividend tax payable can be deducted from your salary or pension.
- Include your dividend income on your self assessment tax return if you already complete one or ask HMRC to open a self assessment tax return if you would prefer to declare the income through self assessment.
Dividend income of more than £10,000
The only option if you have dividend income of more than £10,000 is to declare it on a self assessment tax return.
If you already complete a tax return you can use the same return to include your dividend income.
If you don’t already complete a tax return you should register for self assessment and HMRC will send you a tax return to complete.
Can you reduce dividend tax?
Paying tax on dividends over your tax free allowance thresholds is unavoidable but you can sometimes reduce dividend tax and other shareholder related taxes like capital gains tax (CGT).
Dividend tax for limited company owners:
To reduce dividend tax limited company directors can make use of the option to transfer shares and dividends from those shares to their spouse or civil partner.
In theory if you have a spouse or civil partner who have unused personal tax allowances and/or lower tax rate brackets you can gift some of your shares to them so they pay less tax on the dividends than you would.
It’s important to be aware of the potential pitfalls and restrictions if you are considering transferring dividends to your spouse or family member in this way.
Getting the right share and dividend guidance from your accountant or tax advisor is worth it to make sure you are both financially better off and complying with HMRC legislation.
Dividend tax for investors in a public limited company:
Investors in the stock market with a spouse or civil partner can consider transferring shares between themselves without incurring any tax.
Gifting shares will mean that any dividend income from those shares will be received by the person you have transferred the shares too.
From a tax perspective this could be beneficial if that person pays tax at a lower rate because they would be liable for paying less tax on the dividends compared to what you would have paid.
Captial gains tax on shares:
Transferring shares to a partner can also be an effective strategy to reduce capital gains tax if your selling shares that will trigger a profit exceeding your annual capital gains tax allowance.
A transfer of shares can mean that you can both use your capital gains tax allowances against the profit from shares which will reduce the overall capital gains tax liability.
Dividend tax and individual savings accounts:
Making the most of your (and your partners) annual ISA allowance of up to £20,000 is a good way to pay less income tax because it provides a tax free wrapper.
The ISA allowance is for individuals only and fixed at £20,000 so you can only invest up to that threshold in any one tax year.
It means that you can earn dividend income from stock market investments held within the ISA free from dividend tax and CGT if you sell them for a profit.
You should consider transferring any existing investments into a stocks and shares ISA through a process called Bed & ISA, where you sell your investments and repurchase them within the individual savings account.
