Dividend Tax – How it affects you

By Stuart 2 years agoNo Comments

One of the most important tax changes for small Limited Company owners was announced in the recent budget – the introduction of the dividend tax and dividend allowance.

Using a strategy of low salary (equal to either the NI allowance or personal tax allowance), business owners have then been able to draw out between £28k and £31k (depending on the level of salary used), without incurring any personal tax.

That will change from April 2016!

From April 2016, the first £5,000 of dividends will be tax free. You’ll then pay tax at 7.5% up to the basic rate allowance.

If you’d taken the maximum tax free amount out of the company in 2015/2016 of £38,951 (£8,050 salary and £30,901 in dividend), you would have paid no personal tax.

In the 2016/2017 tax year, withdrawing exactly the same amount of money from the business will result in a tax bill of £1,721.

If there are two of you in the business, currently you’d be able to extract £78k tax free. From April 2016, this will cost £3,442. Not great news for husband and wife companies.

What about those who earn more than the tax free limit?…..

Running through some comparisons of tax payable where the owners draw more than the tax free allowance, and assuming a basic salary of £8,050 in each case shows:

At £50,000 total earnings
Current tax bill £2,775
New tax bill £3,066
Tax increase £291

At £75,000 total earnings
Current tax bill £9,025
New tax bill £11,191
Tax increase £2,161

At £100,000 total earnings
Current tax bill £16,412
New tax bill £19,300
Tax increase £2,884

So there’s an increase for everyone, across the board, not just those staying within the basic rate band.

Looking at the opportunity…….

Without alternative planning, there’s a tax rise for everyone. But how about considering the opportunity?

  • The 10% dividend tax credit is being abolished. This has always caused confusion for small business owners. Basically from April, the dividend you earn for tax purposes will be exactly the same as the dividend cash you withdraw from the company. This means you can withdraw more at the basic rate before paying the higher rate of tax.
  • The basic rate of tax is being extended to £43,000
  • The way that the dividend tax announcement has been worded leads us to believe that the £5,000 allowance will be extending the basic rate band by £5,000.

Note – at the moment, these are assumptions based on the information available from the budget speech and supporting documents. HMRC have yet to issue absolute clarification

If we are to accept that there will be some tax to pay, we could look at the situation from a different angle.

Currently taking £48,000 out of the business would generate a higher rate tax bill of £2,263. Under the new rules, all £48,000 will be available at basic rates, generating a tax bill of £2,400. An increase in tax of just £136.

This leaves us with the situation where we could withdraw £39,000 and pay £1,721 or withdraw an additional £9,000 for an additional tax charge of £679. The extra £9,000 is now attracting a tax rate of 7.5%, rather than 25%. That could be attractive to those who could take more dividend, but choose not to so they didn’t incur a tax bill.

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