From 6 April 2018, investors and people who run their own company could be hit with a bigger tax bill as the tax-free dividend allowance is slashed by £3,000.
The changes were first announced by Chancellor Philip Hammond in the 2017 Budget.
The cut is likely to have a significant impact on employees and directors of small businesses who choose to pay themselves partly or wholly through dividends rather than a salary.
Which? takes a look at how the tax-free dividend allowance is changing what it means for your income.
What is dividend tax?
When you own shares in a company, there are two ways to earn money.
The first is to wait for the company to grow in value, allowing you to make a profit when you sell your shares.
The other way involves companies distributing some of the profits they make to shareholders, annually, in the form of dividends.
While dividends can be a useful way of making money, they are considered a form of taxable income and therefore subject to special dividend tax.
If you have a stocks and shares Isa, you won’t need to pay dividend tax on shares held in an Isa.
For more information about dividend tax, take a look at our short video.
Dividend tax rates 2018/19
From 6 April 2018, you can earn up to £2,000 in dividends before you pay any tax in the 2018/19 tax year.
This has reduced by more than half, from £5,000 in the 2017/18 tax year, which ran between 6 April 2017 and 5 April 2018.
If you earn dividends above the £2,000 allowance, you have to pay tax based on your tax band (also referred to as a ‘marginal tax rate’).
The table below shows the different dividend tax rates for basic, higher and additional-rate taxpayers.
|Income tax band||Rate|
- Find out more: tax on savings
How much more dividend tax will I pay?
The dividend tax-free allowance changes will increase the tax bills of some investors.
The example below shows how much more investors in each tax band will have to pay for earning dividends of £10,000 in the 2018/19 tax year compared to 2017/18.
- Find out more: 2018/19 dividend tax calculator
What rate of dividend tax do I pay?
To find out the rate of dividend tax you have to pay, you’ll need to add your dividend income to your other taxable income (such as your salary and savings income.)
If you live in England, Wales or Northern Ireland, you’ll need to pay income tax according to three marginal tax bands.
If your dividend income pushes you above a certain threshold, you’ll have to pay a higher rate of tax.
|Tax rate||Earnings||2018/19 rate|
|Additional rate||More than £150,000||45%|
- Your annual income from your job is £40,000
- You earn £15,000 in dividend income in that year, taking your total income to £55,000.
You would end up paying the following in dividend tax:
- 0% tax on the first £2,000 of dividends, thanks to the tax-free allowance
- 7.5% on the next £6,350 of dividends, using up the remaining £6,350 on the basic-rate tax threshold
- 32.5% on the last £6,650 of dividends, as this is above the higher-rate tax threshold.
What happens if I pay Scottish Income Tax?
Two new tax bands – ‘starter’ and ‘intermediate’ – have been created, creating five tax bands in total.
|Tax band||Earnings||2018/19 rate|
|Top rate||More than £150,000**||46%|
*Assumes the person is in receipt of the standard UK personal tax-free allowance
**Personal allowance is reduced by £1 for every £2 earned over £100,000
The change has made it more complex if you’re a Scottish taxpayer, as you’ll still need to pay tax on income from savings and dividends using UK tax rates and thresholds.
This means that Scottish taxpayers earning dividends have to use a combination of both Scottish and UK income tax rules to work out how much tax needs to be paid.
- Find out more: Scottish income tax loophole boosts pensions by thousands.
How do I pay dividend tax?
For the 2018/19 tax year, if you earn up to £2,000 in dividends, you don’t need to do anything as this forms part of your tax-free dividend allowance.
If you earn between £2,000 and £10,000, you’ll need to tell HMRC.
You can inform them in one of the following ways:
- Get HMRC to adjust your tax code so that the tax is taken from your salary or pension
- Fill out a self-assessment tax return.
If you earn more than £10,000 in dividends, you need to complete a tax return.
To work out how much tax you need pay on your dividends, give our dividend tax calculator 2018/19 a try.