Dividend Allowance Cut: Will it affect you?

It was confirmed last month in the government’s second finance bill that the dividend allowance will be cut from £5,000 to £2,000. This could result in contractors having to pay a dividend tax bill of up to £1,143.

Phillip Hammond first spoke about the dividend cut in the Spring Budget speech. He said, “People should have choices about how they work, but those choices must not be driven primarily by differences in tax treatment”.

He believes there must not be any difference in tax treatments for employees versus non-employees. Contracting organisations disagree with this statement, though, and say that employees enjoy more benefits than non-employees.

As the dividend allowance cut did not appear in the first Finance Bill, people suspected it may be scrapped along with the Class 4 (self-employed) National insurance contributions increase. Unsurprisingly, this dividend policy did re-appear in a subsequent bill and has since been passed.

Dividend Allowance

The dividend allowance is a fairly new introduction to the tax system. It was introduced in 2016 and implies that dividends are subject to tax based on how much the individual earns.

There are three dividend tax rates; basic rate tax payers pay dividend tax at 7.5%, and higher and additional rate tax payers pay 32.5% and 38.1% respectively.

Like personal allowance, there is a “dividend allowance” of £5,000. This means that the first £5,000 of dividend income is not taxed for limited company shareholders getting paid in dividends. However, this sum is still taken into consideration for overall tax purposes.

As of April 2018, this dividend allowance will fall to £2000.

Will this affect you? If so, by how much?

Your overall income (savings, dividend and non-dividend income) determines how much tax you pay on dividends in 2018. The dividend tax depends on which tax band the first £5,000 falls in. Basic rate tax payers will see an increase in dividend tax by £225. Higher rate and additional rate tax payers will be worse off by £975 and £ 1,143 respectively.

If the dividends (£5000) fall between multiple tax bands, the figures mentioned above will change.

Conclusion: Family businesses are likely to be the most affected by this change, especially if multiple family members take dividend income.