Limited Company Dividends come with earnings as well as some costs (taxes). Many limited companies are not aware of the tax-efficient ways of getting dividends in addition to their basic salaries. In this blog, we will walk you through what is a dividend and a limited company. Moreover, we will discuss how the dividends are taxed. Besides, what is the most efficient way of taxation for the limited companies when they receive dividends?
So, let’s dive into this discussion of limited company dividends!
AccountingFirms is the right place for your company where you can discover the right accountants taking your business to the next level. We are here to assist you.
What is a Limited Company?
A limited company in the UK is liable to follow the Companies Act 2006 and follows the rules prescribed in this act. Moreover, it is registered with the Companies House. Another important attribute of a limited company, unlike a sole trader, is perceived as a separate entity from its shareholders and managers.
If a company has debt in its liability or defaults, the shareholders will bear the loss equal to the stake they have invested. This is why it is known as a limited company due to the limited liability of the shareholders and the members.
What is a Dividend?
A dividend is an income paid to the shareholders on their shares. The board of directors how much profit will be distributed among the shareholders of a company. A public limited company offers dividends on a quarterly or annual basis.
The interim or final dividends distributed among the shareholders are also known as the ‘retained earnings’ and they can are described at the end of the quarterly or yearly report of the company.
A company may or may not pay dividends to its shareholders depending on the cash flow situation of the company. Some companies pay dividends in cash, others also pay in the form of additional shares when stock splits occur.
How Dividends are Taxed in the UK?
The dividends are taxed after deducting the tax allowance every year from your dividends. According to the tax year 2022/23, the dividend allowance is £2000 per year. In other words, the first dividend amount of £2000 is tax-free and you do not need to pay a tax to the HMRC.
If you earn dividends above a threshold of taxable dividend income, you have to pay tax on that additional income. A company pays taxes after deducting the taxes from its profits. However, when they are transferred to the shareholders it becomes a part of their income. So, just like an income tax, the shareholders have to pay a dividend tax on their earnings.
The general rule is to calculate the tax on the dividend received plus income earned from other sources. So, the tax will be calculated on the total income of the shareholders. After this, the shareholders should deduct the dividend allowance first from the total dividend. Lastly, calculate and pay the tax only on the dividend income.
Limited Company Dividend Tax Rates in the UK
Calculating dividend tax might be stressful for the shareholders. It includes a few steps that might become perplexing for the newbies in this equity investment. For this, they need to focus on three things
- Your other Income
- Dividend Income
It is only for the purpose of determining the taxpayer threshold. Tax will be paid only on the dividend after deducting the dividend allowance.
Step 1. Total Income = Other Income + Dividend income
Step 2. Check the Tax-Payer Threshold.
Step 3. Determine if the total income falls in any of the tax brackets defined by the HMRC.
The tax brackets or thresholds are as follows:
- Basic rate tax payer if your income is more than £50,270. The dividend tax rate is 8.75%
- Higher rate tax payer if your total income is up to £150,000. The dividend tax rate is 33.75%
- Additional rate tax payer if total income is more than £150,000. The dividend tax rate is 39.35%
Step 4. After determining the tax threshold and tax rate a shareholder has to pay, subtract the dividend allowance of £2000 from the dividend income.
Step 5. Now calculate the dividend tax on the remaining taxable dividend.
Example of Limited Company Dividend
Suppose you have earned a dividend of £10 000 in a year. Besides, your income from other sources is £40 000.
Step 1. Now find the total income
Total income = other income + Dividend income
= £10 000 + is £40 000.
= is £50 000.
Step 2. Now, determine the tax threshold where your total income falls. Your income is less than the threshold of the basic rate taxpayer, which is £50,270.
Step 3. It means you will pay a dividend tax of 8.75% on your dividend.
You don’t need to pay this tax on the total income. It was only to determine the threshold.
Leave the total income. Bring dividend back to the picture.
Step 4. Subtract the £2000 dividend allowance from the dividend of £ 10000
£10 000 – £2000 = £8000
Step 5. Now, you will pay a tax on the dividend of £8000 at a rate of 8.75%. If your income falls into another threshold, you will pay accordingly. It means the shareholder will pay a tax of £700 on the dividend of £10 000.
The Bottom Line
Wrapping up, we can conclude that dividend income is taxable after determining the tax threshold on your total income. Every individual or self-employed person has to pay a dividend tax on their dividends if their dividend is more than £2 000. In case your dividend income is more than £10 000, you need to notify the HMRC to correct your tax codes accordingly to make an automatic deduction from your salary.
Dividends and the taxes on them can be confusing for you. Legal tax advisors at the AccountingFirms provide personalised tax solutions to elevate your profits. Feel free to contact us.
Disclaimer: All the information provided in this article on Limited Company Dividends, including all the texts and graphics, is general in nature. It does not intend to disregard any of the professional advice.