Dividends – What Are They And What Taxes Do I Pay On Them?
The word ‘dividend’ is quite common in the business world. However, if you are just starting your business, then perhaps you don’t have any idea what exactly a dividend is. So, what is actually a dividend?
Dividends are the amount of money given to the shareholders. This is taken from the profits that the company obtained after taxes, such as Corporation Tax. If you have a limited company, then taking out money from your company through dividends is the most tax-efficient method.
What Is A Dividend?
If you have a limited company and it is earning some profit, then you can share them with your shareholders through dividends. If there is still some money left after you have paid all your expenses, liabilities, and taxes, then that will be your profit.
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Keep in mind that dividends will not be considered as company expense when you are computing your Corporation Tax. Additionally, it is also illegal to give a dividend if your business does not earn an adequate profit after tax.
If the limited company has any retained profit, then they can choose to accumulate them through several months or years. If the directors decide not to share any profits as dividends after the end of the year, then they can be distributed at a later date.
How Dividends Are Issued By The Company?
If you are planning to issue a dividend, then you must hold a meeting with the directors to announce the dividend. There should be someone who will record the minutes of the meeting. This is still executed even if you are the sole director of your company. Although, this is actually just about issuing the appropriate paperwork. If you are using an online accounting software system, then it can handle the admin for you.
Your company is required to issue a dividend voucher every time it pays a dividend. Consequently, the dividend voucher must include pertinent information such as the name of the company, the name of the shareholders who were given dividends, the amount of the dividend as well as the date when the dividend was issued.
There should be two copies of the dividend voucher, one copy will be given to the recipient while the other copy will be kept by the company. The distribution of the dividends will depend on the percentage of shares that the shareholder owns. For instance, if you own 50% of the company’s shares, then you can expect to receive 50% of the dividend every time there is a distribution.
Understanding Tax on Dividends
The company is not required to make any tax payments every time they issue dividends. However, the shareholders must pay tax on the dividends that they obtained depending on their individual circumstances. Generally, this will be done via their annual Self Assessment.
For the 2020/21 tax year, the following conditions will be applied:
Operating your business as a limited company is very tax-efficient since your company or you acting an employee in your company can pay your National Insurance Contributions (NICs) on company dividends.
If your salary is greater than the National Insurance (NI) Primary threshold, then the payable amount for your NICs will include both employer and employee. Most limited company owners would choose to combine dividend payments with a lesser salary to run their business and their finances.
So, how much should you take as a salary if you have a limited company?
Most often, having a limited company is a practical choice, however, there are a lot of things that you need to consider. One of the things that you have to think about when operating your own business is how you are going to get paid by your limited company. This is one of the biggest differences between being employed and having your own business. Generally, the most tax-efficient way of doing this is by combining the salary and the dividends that you get from your limited company. As the director of your limited company, you will be paid by a salary, just like any other employee.
Also, be sure to comply with all the requirements needed such as tax filing responsibilities when operating your payroll under HMRC’s Real-Time Information (RTI). Keep in mind that you will be charged with fines and penalties if you will not comply with the rules.
Understanding the Dividend Allowance
For the 2019/20 and 2020/21 tax years, you can acquire a dividend of up to £2,000 before paying any income tax on your dividends. This amount is on top of your personal allowance of £12,500. On the other hand, for the 2018/19 tax year, the dividend allowance is also set at £2,000, however, the Personal Tax Allowance back then was only £11,850.
Dividend Tax Rates For The Previous Two Tax Years And For The 2020/21 Tax Year
For the past two tax years and for the 2020/21 tax year, the personal tax that you need to pay for your dividends stays the same. For Basic-rate taxpayers, the rate is 7.5%, for Higher-rate taxpayers, you will pay 32.5% and 38.1% for the additional-rate taxpayers.
Dividend Tax Thresholds For The 2020/21 Tax Year
After the personal allowance of £12,500 is used, these are the tax rates and tax thresholds that must be applied. For the basic rate, the Dividend Tax rate is 7.5%. This applies to dividends from £2,000 up to £37,500. For the Higher Rate, the Dividend Tax rate is 32.5%, applicable for dividends from £37,501 up to £150,000. And lastly, for the Additional Rate, the Dividend Tax rate is 38.1%, to be used for dividends of £150,000 and up.
An Example Computation For The 2020/21 Tax Year
The salary of a company director is £8,788, which belongs to the National Insurance Secondary Threshold. For the 2020/21 tax year, he was able to earn an income of £50,000 from dividends. He also has a personal allowance of £12,500. These are the Income Tax rates that he needs to pay for the 2020/21 tax year.
For his salary of £8,788, this is tax-free due to the Personal Allowance of £12,500. For his £50,000 income from dividends, we will have to break them down. The amount of £3,712 from Dividends is still tax-free because of the Personal Allowance of £12,500. The next amount of £2,000 from Dividends is also tax-free because of the Dividend Allowance of £2,000. For the next £35,500 from Dividends, you’ll have to pay the Basic Rate of 7.5% for the Dividend Tax which is equivalent to £2,662.50. Finally, for the remaining £8,788 from Dividends, we will use the Higher Rate of 32.5% for the Dividend Tax which is equivalent to £2,856.10. Therefore, the total income tax that you need to pay will be £5,518.60.
What Is The Maximum Amount Of Salary And Dividends Needed To Avoid Paying Higher Rate Tax?
In the following example, we will show you the maximum amount that you can take for the salary and dividends so you can remain in the Basic Rate band. This computation is intended for both the 2019/20 and 2020/21 tax years.
For the 2019/20 tax year, we will set the salary at £8,632, which belongs to National Insurance (Primary Threshold). The dividends earned for this year is £41,368. All in all, the total income for this year is £50,000. After taking the Personal allowance of £12,500, the remaining balance is £37,500, which is also the taxable income. After deducting the Dividend Allowance of £2,000, the remaining taxable dividend is £35,500. By applying the Basic Rate of 7.5% for the Dividend Tax, the amount of your income tax due would be £2,662.50.
For the 2020/21 tax year, the amount of salary is £8,788, which is within the National Insurance (Secondary Threshold). The total dividends earned are £41,212. The overall total of his income would be £50,000. By deducting the Personal allowance of £12,500, the remaining taxable income would be 37,500. We will subtract the Dividend Allowance of £2,000 to get a remaining dividend taxable amount of £35,500. By using the Basic Rate of 7.5% for the Dividend Tax, the amount of your income tax due would be £2,662.50.
In this example, we will take into account that the salary that we use is the relevant National Insurance (Primary Threshold), which is £8,632 for the 2019/20 tax year. And for the 2020/21 tax year, the amount of salary is of relevance to the National Insurance (Secondary Threshold) which is set at £8,788. Also, this is considered as your only source of income.