[Lauren]

Hey everyone,

If you're self-employed and own a limited company, you may choose to only pay yourself in dividends. Others might opt for a combination alongside their salary.

Personal preference plays a role in this choice but dividends have the added benefit of often being more tax-efficient when compared to the traditional Pay as You Earn (PAYE).

You’re probably busy working on jobs for customers and don’t have much time for paperwork. That’s why we’ve put together this in-depth guide to take you through everything you need to know. It comes an important time, with the government recently announcing a dividend tax rise of 1.25% from 6 April 2022. So read on to understand your obligations and pay yourself properly without making a costly mistake.

Only got five minutes and need a quick answer? No problem – scroll down to the FAQs for a quick overview.

Sole traders and limited companies – what you need to know
As a sole trader, you are responsible for any losses or debts acquired by your business. Sole traders pay tax at the same rate as employees meaning they are only affected by income tax. They also have a tax-free allowance of £11,850, unless they have an income of above £100,000. However, those who register their business in this way can sometimes end up paying more in corporation tax.

Limited companies don’t pay income tax or National Insurance. Instead, they pay corporation tax on all their profits, with the current rate set at 19%. The company’s directors will also be liable for personal tax on any salary they pay themselves, as well as any dividends they draw. This may sound like a less desirable choice when compared to sole traders but it’s important to note that directors cannot be held personally responsible for any incurred debts unless they have signed as a guarantor. Ultimately, there’s better legal protection.

Adding a director to the payroll can make tax complicated. Instead, look to pay a year-end dividend. For more important information about the differences between sole traders and limited companies, click here.

Dividend tax rates – everything you need to know
Paying tax on dividends depends on the income tax band you fall into. There are three tax bands:

• Basic rate
• Higher rate
• Additional rate

Each translates into a different tax rate on dividends over the government’s allowance. There is no tax payable on the first £2,000 of dividend income, as a result of the dividend allowance. If your yearly dividend is less than £37,500, it will currently be charged at 7.5% tax. A yearly dividend of less than £150,000 will be charged at a higher rate of 32.5%. Finally, if you receive over £150,000 in yearly dividends you will be required to pay an additional rate of 38.1%.

To work out your tax band, add your total dividend income to your other income. This may mean you end up paying tax at more than one rate. Still confused? Don’t worry there are plenty of useful online tools, like online dividend tax calculators, to help you settle your outgoings for the 2020/21 tax year. Some will even offer projections based on the government’s tax hike coming into effect in 2022.

How much dividend can I pay myself tax free?
According to the government’s website, you can earn some dividend income each year without paying tax. You do not pay tax on any dividend income that falls within your personal allowance (this is the amount of income you can earn each year without paying tax). The personal allowance for 20/21 remains at £12,500.

Be aware that the rules for freelancers are different and can be complicated for those doing work on the side for the first time. You can read more about that here.

Tax-free dividend allowance
You also get a dividend allowance each year, which means that you only pay tax on any dividend income above the dividend allowance. It’s also worth noting that you do not pay tax on dividends from shares in an ISA.

Do you pay corporation tax on dividends?
Corporation tax is applied to the profits of all limited companies. If you’ve registered as one, you’ll need to file and pay corporation tax. Prepare a company return based on your business’s accounts to work out how exactly much you owe. You will then pay the total or report there’s nothing owed by the deadline.

Remember to always file a company tax return by the deadline which is usually 12 months after the end of your accounting period. For more information about digital taxes and making your life easier, click here.

Tax on reinvested dividends UK
Generally, dividends earned on stocks or mutual funds are taxable for the year in which the dividend is paid to you, even if you reinvest your earnings.

FAQs
How much tax do you pay on dividends?
This depends on the income tax band you fall into. The dividend tax rates for 2021/22 tax year are: 7.5% (basic), 32.5% (higher) and 38.1% (additional).

How do I avoid paying tax on dividends?
You can take advantage of this year’s ISA allowance as investments within these accounts aren’t subject to dividend tax. Married couples and civil partners should also spread taxable portfolios between them to make the most of each person’s dividend allowance, personal allowance and basic rate tax band.

How much of dividend is tax free in the UK?
Any tax that falls within your personal allowance is the amount of dividend income you can earn each year without paying tax.

We hope this article helps, let us know in the comments below👇