For many owner-managed businesses, dividends are a common way to extract profits from the company, but evolving tax rules are making this method less tax-efficient than it once was. These changes, announced as part of ongoing government efforts to balance the economy post-pandemic, will affect how business owners structure their income.
In this post, we’ll explore the key changes to dividend taxation and provide guidance on what they mean for you in the 2024/25 tax year.
Overview of the Current Dividend Tax System
Before diving into the changes, it is essential to understand the current dividend tax structure. In the UK, dividends are subject to different tax rates than salaries, with a tax-free Dividend Allowance and progressively higher tax rates depending on the taxpayer’s income band.
For 2023/24, the key thresholds were:
Dividend Allowance: £1,000 (reduced from £2,000 in the previous year)
Basic Rate: 8.75%
Higher Rate: 33.75%
Additional Rate: 39.35%
Dividends are paid from post-tax profits, meaning the company must first pay Corporation Tax (currently 19% and 25% for most businesses) before distributing dividends to shareholders.
What is Changing in 2024/25?
The most significant changes to dividend taxation for the 2024/25 financial year include further reductions to the Dividend Allowance and adjustments to the tax rates for higher earners. Here’s what you need to know:
1. Reduction in the Dividend Allowance
The Dividend Allowance, which provides tax-free income on dividends, is set to reduce again from £1,000 in 2023/24 to £500 for the 2024/25 tax year. This reduction significantly narrows the window for tax-free dividend income, pushing more dividend income into taxable bands.
2. Dividend Tax Rates Remain High
While there has been no further increase in the tax rates for dividends in the 2024/25 tax year, the high rates introduced in recent years (8.75%, 33.75%, and 39.35%) remain in place. The combination of these rates with the reduced Dividend Allowance means that many business owners will face higher tax bills on their dividend income compared to previous years.
3. Potential Impact of Income Tax Bands
While the dividend tax rates haven’t increased, changes to income tax bands, especially for higher earners, could impact how much you pay on your dividends. Those on the cusp of the higher-rate or additional-rate tax bands may find themselves paying significantly more as their total income, including dividends, pushes them into higher tax thresholds.
Implications for Business Owners
1. Increased Tax Burden on Dividends
For owner-managed businesses, dividends have long been a tax-efficient way to extract profits compared to a salary. However, with the reduction in the Dividend Allowance and the continued high dividend tax rates, the attractiveness of dividends is diminishing. Business owners who rely heavily on dividend payments as a form of income will need to reassess their overall tax strategy.
2. Considering Alternative Income Structures
Given the changes, business owners may want to explore other ways to structure their income and minimize tax liability. Some possible strategies include:
Taking a larger salary: With the Corporation Tax rate now at 25%, some business owners may find it more efficient to take a salary, especially if they can take advantage of personal allowances and pension contributions.
Pension contributions: Pension contributions are one of the few remaining tax-efficient ways to extract value from a business. By maximizing pension contributions, you can reduce your taxable income while saving for retirement.
Dividend timing: Some business owners may choose to accelerate dividend payments into the current tax year before the Dividend Allowance reduction takes effect. However, this must be balanced against overall tax planning.
3. Importance of Planning and Professional Advice
With the changes to dividend taxation, tax planning is more important than ever. Business owners should work closely with accountants and tax advisors to ensure they are taking the most tax-efficient approach to extracting profits from their company. Strategies such as spreading dividend payments, maximising pension contributions, and optimising salary vs. dividend combinations will be essential for minimizing tax liabilities.
The 2024/25 financial year brings important changes to dividend taxation that will affect many business owners across the UK. The reduction in the Dividend Allowance and the continued high tax rates on dividends mean that business owners will need to be more strategic about how they take income from their businesses. By staying informed and seeking professional advice, business owners can navigate these changes and develop tax-efficient strategies that work for their unique situations.
If you haven’t yet reviewed your dividend strategy for the upcoming tax year, now is the time to do so.
Working with a financial advisor can help you make the most of the available allowances and mitigate the impact of these tax changes.
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