Are you prepared for the dividend allowance cut on your January 2020 tax return?

Dividend complexities
The dividend allowance, which was originally introduced from 6 April 2016, was cut from £5,000 a year to £2,000 from 6 April 2018. The cut is likely to have a significant impact on employees and directors of small businesses who receive both salary and dividend payments.
Many family-owned companies allocate dividends towards the end of their financial year and/or the tax year, so it was not until March/April 2019 that the impact of the reduction first started to hit home. Unfortunately, many other taxpayers may not become aware of the change until they complete their 2018/19 tax return, which in most cases, will be due for submission to HMRC by 31 January 2020.
How much tax is paid on dividend income is determined by the amount of overall income the taxpayer receives. This includes earnings, savings, dividend and non-dividend income. The dividend tax will primarily depend on which tax band the first £2,000 falls in.
The tax rates on dividend income, above the allowance, remain at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.
For a basic rate taxpayer, the reduction in the allowance means an increase in tax paid on dividends of £225. For a higher rate taxpayer, the reduction increases the annual tax bill on dividends by £975, and for additional rate taxpayers, the increase is £1,143. Note that if dividend income falls between multiple tax bands, these figures will be different.
Dividend income is taxed at the taxpayer’s highest rate. This can often work in the taxpayers favour, particularly where a mixture of salary and dividends is received. For example, if a director receives a salary of £40,000 and a dividend of £12,000, their tax liability for 2019/20 will be as follows:

In this example, personal allowances are deducted first against the salary, leaving £27,500 of other income falling within the basic rate tax band (£37,500 for 2019/20). Dividend income falling within the basic rate band is £10,000 (£37,500 minus £27,500 used), with the remaining £2,000 falling above the basic rate limit. The dividend nil rate is allocated to the first £2,000 of dividend income, falling wholly within the basic rate band, leaving £8,000 within the basic rate band and taxable at the lower 7.5% rate. The remaining £2,000 of dividend income is taxable at the dividend upper rate of 32.5%.
Individuals who are not registered for self-assessment generally do not need to inform HMRC where they receive dividend income of up to £2,000. Those with income between £2,000 and £10,000 will need to report it to HMRC. The tax can usually be paid via a restriction to the PAYE tax code number, so that it is deducted from salary or pension. Alternatively, the taxpayer can complete a self-assessment tax return and the tax can be paid in the usual way (generally 31 January following the end of the tax year in which the income was received). Those receiving more than £10,000 in dividends will need to complete a tax return.
The allocation of various rate bands and tax rates can be complicated, even in situations where straight-forward dividend payments are made. Family business structures may be particularly vulnerable to the impact of the reduction in the dividend allowance, especially where multiple family members take dividends from the family company. A pre-dividend review may be beneficial is such cases.
Partner Note: ITA 20017, s 8 and s 13A

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Year-end tax planning tips

As the end of the 2018/19 tax year approaches, it is worthwhile taking time for some last-minute tax planning. Here are some simple tips that may save you money.

  1. Preserve your personal allowance: the personal allowance is reduced by £1 for every £2 by which income exceeds £100,000. For 2018/19, the personal tax allowance is £11,850, meaning that it is lost entirely once income exceeds £123,700. Where income falls between £100,000 and £123,700, the effect of the taper means that the marginal rate of tax is a whopping 60%. Where income is over £100,000, consider making pension contributions or charitable donations to reduce income and preserve the personal allowance. Where this is an option, consider also deferring income until after 6 April 2019 to reduce 2018/19 income.
  2. Claim the marriage allowance: the marriage allowance can save a couple tax of £238 in 2018/19. Where an individual is unable to utilise their personal allowance, they can make use of the marriage allowance to transfer 10% of their personal allowance (rounded up to the nearest £10) to their spouse or civil partner, as long as neither pay tax at the higher or additional rate. The marriage allowance must be claimed.
  3. Pay dividends to use up the dividend allowance: family and personal companies with sufficient retained profits should consider paying dividends to shareholders who have not yet used up their dividend allowance for 2018/19. The dividend allowance is set at £2,000 and is available to all individuals, regardless of the rate at which they pay tax. The use of an alphabet share structure enables individuals to tailor dividend payments according to the individual’s circumstances.
  4. Make pension contributions: tax relieved pension contributions can be made up to 100% of earnings, capped at the level of the annual allowance. The annual allowance is set at £40,000 for 2018/19 (subject to the reduction for high earners). Where the annual allowance is not used up in year, it can be carried forward for up to three years.
  5. Transfer income-earning assets to a spouse or civil partner: where one spouse or civil partner has unused personal allowances or has not fully utilised their basic rate band, considering transferring income earning assets into their name to reduce the combined tax liability (but non-tax considerations such as loss of ownership should be taken into account).
  6. Put assets in joint name prior to sale: spouses and civil partners can transfer assets between them at a value that gives rise to neither a gain nor a loss. This can be useful prior to selling an asset which will realise a gain in order to take advantage of both partners’ annual exempt amount for capital gains tax purposes.
  7. Make gifts for inheritance tax purposes: individuals have an annual exemption for inheritance tax of £3,000, allowing them to make gifts free of inheritance tax each year. Where the allowance is not used, it can be carried forward to the next year, but is then lost.

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