Higher taxes for dividend income from 2016

If you’re an SME online retailer with a Limited company and don’t draw a salary (or only draw a small salary) and rely on dividends then you need to be aware that from the 2016/2017 tax year you’ll be taking less home. The Chancellor of the Exchequer, George Osborne, announced in the budget tax changes which every Limited company owner needs to be aware of and make tax plans before April of next year.

At the present, dividends are paid with a notional 10% tax credit. This means that for non tax payers there is nothing further to pay and even for Basic Rate tax payers there is no further tax liability. Currently it’s only if you fall into the Higher Rate tax band that you’d be liable for tax.

From April 2016 the tax on dividends will change, mainly intended to close the loophole where businesses “pay” their employees via dividends avoiding full income tax liability.

Every investor in a company (regardless of whether they’re also an employee) will have an annual tax-free dividend allowance of £5,000. Over and above that allowance you’ll start to pay tax and that includes those on Basic Rate, Higher Rate and those falling into the Additional Rate tax bracket.

The result of this is that currently if you pay yourself as little as £6000 in annual dividends, as a lower rate tax payer this will be free of further taxation. From April 2016 you’d be liable for tax of £75 at current rates on the £1000 in excess of the £5000 tax free dividend limit. The more you draw as dividends the more you’ll pay.

There’s plenty of time to consult with your accountant – for instance if you’re a higher rate tax payer you’ll be hit even harder so you may like to choose to have dividends paid to your spouse if he/she is a lower rate tax payer. You might also wish to open a stocks & shares ISA which could shelter your dividends from taxation (make sure you put the shares from companies with the highest yields rather than those that pay lower dividends into your stocks & shares ISA to minimise your tax liability).

Do you “pay” yourself with dividends rather than through PAYE? Do you know how will the tax changes from 2016 affect your income?