Tom Walker shares the questions to ask of your advisor in relation to dividend rate plans and changes when completing your tax return.
You may recall our post following the Emergency Budget about how the dividend tax rate is changing. Well, we’re now approaching the end of the year and that means tax return season. You now have a small window of opportunity to plan and maximise your income and drawings before the new dividend rates kick in from April 2016.
The current system of applying a tax credit to dividends will be scrapped which will make life simpler. Your tax liability calculation will be based purely on what you have paid yourself. That’s the good news, unfortunately the new rates are more punitive, hence the potential need to plan before they kick in.
So if you’re a company owner and pay yourself dividends, we’ve developed the following questions to ask yourself and your accountant/advisor:
Are you paying yourself a tax free salary?
Despite the dividend tax changes, the likelihood is you should pay yourself a small salary. This will be more tax efficient because it is tax free to a specific level and thereby also saves the company in corporation tax. Much of this will depend on your total income and how much you derive from other income sources.
How much income should you withdraw?
With dividend tax rates going up the temptation would be to withdraw as much dividend income this year as possible. However, your additional dividends could push you into higher tax rates which could result in you potentially paying more this year than next without careful planning.
You also need to consider the income level at which your personal allowance is withdrawn and whether you risk becoming an additional rate tax payer.
Extracting the maximum tax free dividend in 2015/16?
The changes for April 2016 mean the era of tax free dividends will come to an end. That means your 2015/16 tax return will be your last opportunity to make use of the tax free dividend allowance. Be sure to do this where possible.
The chances are you will benefit from taking as much tax free dividend as possible this year. How much better off will you be? This will depend largely on the different sources of income you might have.
Should you pay yourself a bigger dividend this tax year?
This comes down to your circumstances. If you own and run a growing business then you may expect profits and therefore your income to rise significantly in the next tax year.
Should you expect to pay yourself the maximum tax free allowance of £42,385 in 2015/16 and next year’s dividend income to then rise above that level, then that will take you into the higher rate band. Better therefore to frontload next year’s income into this year so that you pay the higher rate at 25% instead of 32.5% after April 2016?
The thing is you can only pay yourself dividend income if your company has sufficient distributable profits in the current tax year. You also need to be certain of this strategy, if you’re right you’ll save 7.5% but if you’re wrong you’ll loose 17.5% because you’ll pay 25% higher rate tax this tax year as opposed to the 7.5% basic rate next tax year. Splitting dividend income between tax years may therefore be an efficient solution to explore with your advisor.
What about dividend strategies for higher rate tax payers?
For higher rate tax payers, savings may be achieved by extracting more in dividend income this year than next. That way, assuming you stay within the limit of your higher rate band, more of your income will be taxed at 25% this year as opposed to the new rate of 32.5% next tax year.
Be warned though, once you exceed £100,000 of income, your personal allowance is withdrawn moderately. Every £2 of additional income above £100,000 means your personal allowance is reduced by £1, so don’t overdo it.
Can you avoid the child benefit tax charge?
Child benefit is gradually withdrawn where any member of a household earns over £50,000 in income. At £60,000 all of the child benefit is effectively taken away in higher tax charges. Consider this carefully with strategies of front loading dividend income into this tax year if applicable to you.
What are the issues facing higher income earners?
At an income level of £121,200 in 2015/16, your personal allowance is taken away completely. What this means is if your income is between £100,000 and £121,200 then your marginal rate of tax on your cash dividends will be 48.6%. So if your income is close to £100,000 it may not be worth taking more in this tax year. It all depends on the amount of additional dividend.
For income above £121,200 then additional dividends are charged at 25% tax. At £150,000 the additional rate of tax comes in at 30.6% on dividends. It may therefore be advantageous at this level to pay 30.56% this tax year as opposed to 38.1% next year.
Any other items to consider in dividend tax planning?
Consider company pension contributions which provide no immediate tax liability for the director
You could also potentially split income with a partner or spouse who is actively involved in the business but be sure to seek professional advice on this matter
The content of this post is up to date and relevant as at 23/11/2015.
Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.