Although the dividend tax has been in place for a while, talking to clients it is still much misunderstood so this blog aims to explain the dividend tax liabilities that arise when a shareholder takes dividends.
The good news is the first £5,000 of dividend income is tax-free. The bad news is the rest is charged depending on what income tax band rate you are in.
If you are in the basic rate tax band, it is charged at 7.5%, if you are in the higher rate band the rate is 32.5% and in the additional rate band it is taxed at 38.1%.
Looking at a basic example, let's say a director takes a salary of £40,000 and pays herself a dividend of £25,000 - how would this be taxed?
Well, ignoring NI for simplicity, the salary would be taxed as follows:
40,000 less the personal allowance in 2017/18 of £11,500 leaves £28,500 taxed at basic rate of 20% = £5,700. (The basic rate band upper limit is £45,000 for 2017/18).
But what about the dividends?
As above the first £5,000 is tax-free, so that leaves £20,000 chargeable to dividend tax. The director had £5,000 left of her basic rate band so that is now covered by the nil rate dividend band. The remaining £20,000 is taxed at the higher rate of 32.5% ... £20,000 * 32.5% = £6,500.