Now is the Time to Save Tax on Dividends

Last year, the Chancellor announced a huge change in how we tax dividends. For many years, company owners have been able to take advantage of splitting their income between salary and dividends to minimise their personal tax liability. March 2016 is your last chance to save tax on dividends, before a 7.5% income tax increase.

At present, the higher rate tax threshold is £42,385. If salary is kept at £8,060 (under the lower earnings limit) and any remaining income is taken as a dividend, then providing this limit is not exceeded (Including gross dividend) then no income tax is payable.

From April 2016, dividends will be taxed at 7.5%, however there are further changes to soften the blow slightly. Dividend tax credits will be abolished, meaning that the actual cash paid will generate the dividend amount. At present, the amount physically paid is grossed up 10/9 and deemed to be received net of 10% tax.

Further to this a £5,000 “dividend allowance” will be introduced, this will be applicable to taxpayers across the board. This allowance will use up part of your basic rate band, making the current dividend and salary mix less attractive from 2016-17.

So what do you need to do to maximise your tax relief?

In order to pay as little tax as possible and not waste the last chance to receive a tax free dividend, you would need to take the maximum dividend possible before 5 April 2016.

Working out your maximum dividend is where it gets trickier. In order to get the most benefit as a basic rate tax payer, you need to work out a dividend to take you to the £42,385 limit. So first of all, you need to access what other income you have.

After accounting for your other income, any remaining amount will be your gross dividend, this would have 10% deducted to form the cash dividend paid by the company.

Before declaring this dividend you must ensure the company has sufficient distributable profits. This needs to be done before March 2016, you may need to discuss this with your accountant in advance and ensure that the up to date management figures show that this is the case.

How much can you save?

In the case of someone that draws a £8,060 salary, taking the maximum dividend in this year compared to next year will save £2,317 in income tax! For someone with taxable income of £20,000, this saving would be £1,511.

What else should you consider?

Higher rate tax payers will also see an increase in the tax that they pay on dividends, so where you expect to meet the higher rate threshold next year, it is worth paying only 25% this year, rather than 32.5% next year. This is of course a gamble in next year’s profits and could see you paying 25% this year and not using your basic rate band next year, in which case it would only have been taxed at 7.5%.

Again the rules will also effect high income earners, with earnings over £100,000. At this rate the personal allowance is gradually withdrawn and this should be considered when assessing any potential savings.

There is also additional tax savings within this year where pension contributions are made and therefore increase the basic rate band, however this involves tying up even more cash and would not be a viable option in a lot of cases.