As the end of the tax year approaches, now is the time for small company directors and shareholders to take proactive steps to minimise their tax liabilities, especially on dividend payments. Careful tax planning is essential to ensure that dividends are taken in the most tax efficient manner.
Year-end tax planning – tax-free dividend allowance
The dividend allowance was reduced to just £500 from April 2024, down from the previous £1,000 in 2023/24. This means that only the first £500 of dividend income will be tax-free, with the remainder taxed at the standard dividend tax rates. These rates remain unchanged at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.35% for additional rate taxpayers. This reduction in the dividend allowance makes it even more important to consider alternative tax-efficient strategies.
The impact of income tax bands
A key consideration is ensuring that total income remains within the most beneficial tax bands. The basic rate band extends up to £50,270, and dividends taken within this band will be taxed at the lowest rate of 8.75%. However, exceeding this threshold will push dividend income into the higher rate of 33.75%, significantly increasing the tax burden. Moreover, for individuals earning over £100,000, the personal allowance of £12,570 is gradually withdrawn, resulting in an effective marginal tax rate of 60% between £100,000 and £125,140. Careful dividend planning or utilising other planning techniques (such as employer pension contributions in lieu of salary or dividends) can help avoid this highly taxed income band
Year-end Tax Planning – timing of dividend payments
Dividends should also be timed strategically. Because dividends are taxed in the year they are paid, company directors have flexibility over when they declare and withdraw them. If a higher income is expected in the following tax year, it may be wise to take dividends before 5 April 2025 to use the lower rates while available. On the other hand, if a lower-income year is anticipated, deferring dividends may be beneficial.
Year-end Tax Planning – Dividends or salary?
Balancing dividends with salary is another crucial aspect of tax-efficient planning. A common strategy is for directors to take a low salary up to the National Insurance threshold, which for 2024/25 remains at £12,570, and supplement income with dividends. This ensures that the personal allowance is used while minimising National Insurance contributions. For those wanting to extract additional funds from their company, employer pension contributions offer a tax-efficient alternative, as these are deductible for corporation tax purposes and not subject to income tax or National Insurance.
Avoiding directors’ loan tax charge
Company directors should also be mindful of their Director’s Loan Account. If money has been borrowed from the company, it must be repaid within nine months of the company’s year-end to avoid a 33.75% Section 455 tax charge. There are also personal tax implications of borrowing more than £10,000. Alternatively, if the company owes the director money, repaying loans instead of taking dividends can be a tax-free way to extract funds.
Making use of spouse’s lower tax rates
Another key tax-saving strategy is to possibly make use of a spouse’s tax allowances. If a spouse has a lower income or unused personal allowance, it may be possible to pay dividends by having different classes of shares. This may reduce the family’s overall tax liability by shifting income into a lower tax band.
Need help with year-end tax planning? Why not set up an initial planning session now?
Every company, and its directors are subject to their own set of unique and specific circumstances and these will determine planning options for 2024-25. Whilst there is still time to act, please call us now so we can review your dividends v salary options before the end of the current tax year.
If you would like to arrange a free initial consultation with a member of our team to discuss the payment of dividends and your options when considering salaries v dividends please contact us on 020 7870 9050.
