Dividends Tax Explained

What is dividend tax?

Once you pull in a certain amount of money, the government will want its cut. That applies not only to salaries but also to other income, including investment gains.

When you sell at a profit or shares you own reward you with a portion of company earnings in the form of a dividend, HMRC will normally expect you to declare and pay tax on it.

» MORE: About paying tax

How are dividends taxed?

Every year, the government grants investors a tax-free dividend allowance. At present, income payments from investments under £2,000 aren’t taxed, and that’s been the case since 2018 when the exemption was cut from £5,000.

Dividends can count towards your personal allowance, too, provided it hasn’t already been exhausted by other income streams, such as salary or pension. Anyone making under £125,000 can currently earn up to £12,500 each fiscal year without paying tax, so if the only income you receive from April to April is dividends and they total less than £14,500 you don’t owe the taxman anything.

» MORE: About the personal savings allowance

How much are dividends taxed?

When allowances are surpassed, UK residents must pay tax. How much depends on the category of taxpayer you are. Dividend tax rates are based on your overall earnings and, as you can see in the table below, are lower than what you pay on other income.

Source: UK Government *Income tax bands differ slightly for people living in Scotland

To work out your tax band, add dividend takings to all other sources of taxable income. Say Tina earnt £40,000 from her day job and received £12,000 in dividends during the 2020/21 fiscal year. This would give her a total income of £52,000. Tina’s personal allowance would then be used up by her salary, leaving £27,500 to be taxed at the basic income rate of 20%, and a bill of £5,500.

Moving onto the dividends, after subtracting the £2,000 exemption, Tina is left with £10,000 taxable dividend income. Some £8,000 of this is taxed at the basic rate of 7.5%, with the remaining £2,000 entering the higher 32.5% bracket, meaning she owes HMRC a further £1,250 for these earnings.

Dividends enter the equation only after tallying up income from work, pensions, property, and then interest on savings accounts. As illustrated, coming last is generally a good thing because these payments are subject to lower taxation.

» MORE: About income tax

How do I pay tax on dividends?

If you pocket more than £2,000 in dividends, you’ll need to let HMRC know. For returns of £10,000 or less, you can ask the tax authority to adjust your tax code so that the money is taken directly from your wages or pension.

That option disappears when annual dividend income exceeds £10,000. In such cases, the only available path is to file a separate self-assessment tax return.

How to avoid tax on dividends

Luckily, there just so happens to be a legal way to significantly reduce or completely wriggle out of paying dividend tax: investing through a stocks and shares ISA. All UK residents over 18 can deposit up to £20,000 each year into these accounts, with any funds held within them shielded from dividend and capital gains tax obligations.

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you

Image source: Getty images