MMV296 – Dividend Taxation Explained
How dividends are taxed is changing in April 2016. The first MeaningfulMoney video in three years (woohoo!) explains what you need to know about dividend taxation.
The current system of dividend taxation
At the moment, and for many years, dividends have been taxed in a weird way. Whatever you receive in dividends is deemed to be a net amount. And net of 10%, so….
If you receive a dividend of £90, it is deemed that the gross amount is £100, and the difference of £10 is called a dividend tax credit. It's important that you understand that this £10 is not real money. It is notionally added, that's all. Prior to 1997, it was possible for non-taxpayers, PEPs/ISAs and pensions to claim back the fake money, so it wasn't fake at all.
That tax credit means that if you're a basic rate taxpayer, you have no further tax to pay on your dividend, but if you're a higher or additional rate taxpayer, then you will have further tax to pay.
How dividends are taxed after April 2016
Fortunately, the weird money-but-not-real-money anomaly of the dividend tax credit is being done away with in April 2016.
Unfortunately, if you're a business owner who pays yourself mostly via dividends, you're going to be paying more tax than you were.
Tax free allowance
Under the new rules, the first £5,000 of dividend income in any one tax year is ignored for tax purposes. This means that most people with investment portfolios which produce dividend income of less than £5,000 per year, will have no tax to pay, no matter what their tax status.
New tax rates
Any excess dividend income above the £5,000 allowance, is added to your other income in that tax year, and taxed at three rates:
- Basic Rate: 7.5%
- Higher Rate: 32.5%
- Additional Rate: 38.1%
What can you do about it?
The obvious thing to do is to shelter as much of your dividend paying investments into ISAs and pensions.
You could also shift into lower yielding investments, so the dividend income is reduced, and instead go for growth where you can make use of your Capital Gains tax allowance to make more money tax free.
If you're a business owner paying yourself in dividends however, you're a little bit stuck. You will certainly pay more tax than you are now. But, dividends is still the most tax-efficient way to pay yourself, compared with, say, increasing your salary.
Any questions? Leave 'em in the comments.