Over the past few years, limited company directors have faced an increasing tax burden due to the gradual reduction of the dividend allowance. Once £5,000 in 2017, the tax-free dividend allowance has steadily decreased and, as of April 2024, is set at just £500. This change has significantly impacted the tax efficiency of dividends and has forced many business owners to reassess their strategy.
In this blog, we’ll explore the implications of these changes, what they mean for limited company directors, and what steps can be taken to mitigate the impact.
How the Dividend Allowance Works
The dividend allowance is the amount of dividend income an individual can receive tax-free in a given tax year. Beyond this threshold, dividends are taxed at the following rates for the 2024/25 tax year:
- 8.75% for basic rate taxpayers
- 33.75% for higher rate taxpayers
- 39.35% for additional rate taxpayers
So, anyone receiving dividends beyond the £500 threshold must pay tax at these rates, in addition to any corporation tax already paid by the company.
Impact on Limited Company Directors
For many small business owners and contractors operating through a limited company, dividends have long been a key strategy to minimise tax liabilities. Typically, a director will take a small salary (often at or around the National Insurance threshold) and top up their income with dividends to avoid higher rates of tax.
However, with the dividend allowance being reduced to just £500, this strategy is becoming less effective. So, here’s how the changes impact limited company directors:
1. Higher Personal Tax Bills
With the reduction of the tax-free dividend allowance, more of a director’s income is now subject to taxation. For example, a director who previously took £2,000 in dividends tax-free in 2022/23 will now pay tax on £1,500 of that amount in 2024/25.
If they fall into the basic rate tax bracket, this means an extra £131.25 in tax each year. For a higher rate taxpayer, the additional tax rises to £506.25. And, for additional rate taxpayers this jumps to £590.25.
2. Reduced Tax Efficiency of the Salary-Dividend Split
Many limited company directors structure their income by taking a small salary (often around the personal allowance threshold) and paying themselves the remainder in dividends. This approach worked well when the tax-free dividend allowance was higher, but now, with just £500 tax-free, the gap between salary and dividends is narrowing in terms of tax efficiency.
Therefore, directors, like yourself, may now need to rethink this structure to avoid higher personal tax bills.
3. Increased Corporation Tax Liabilities
Another factor to consider is corporation tax, which follows a tiered structure as of April 2023:
- 19% for profits up to £50,000 (small profits rate)
- 25% for profits above £250,000 (main rate)
- A marginal rate of 26.5% for profits between £50,000 and £250,000
As a result, company directors must now carefully balance their remuneration strategy to optimise both personal and corporate tax efficiency.
Speak to our accountants about how you can ensure you’re using the most tax-efficient strategy when it comes to receiving your limited company earnings. Our team at Graham Wood are well-equipped to make sure you’re utilising the most tax-efficient strategy for you and your company.
What Can Business Owners Do?
The reduction in dividend allowance means it’s more important than ever for business owners to plan their finances strategically. Here are some key ways to mitigate the impact of these changes which could affect your limited company earnings:
1. Review Tax Planning with an Accountant
Seeking professional advice is essential to develop a tax-efficient income strategy. An accountant can help explore alternative remuneration options whilst ensuring you remain compliant with tax regulations. Here at Graham Wood, this is something we excel at. So, don’t hesitate to get in touch with our accountants.
2. Adjust Salary and Dividend Ratios
Directors may need to reconsider the balance between salary and dividends to maximise their limited company earnings. With the lower dividend allowance and higher dividend tax rates, increasing your salary slightly (while remaining tax-efficient) may be worth considering.
3. Consider Pension Contributions
Did you know that pension contributions are a highly tax-efficient way to extract money from a limited company? Contributions made directly from the business can be offset against corporation tax. This reduces the overall tax liability while helping directors save for the future.
4. Utilise Spouse’s Allowance
For directors who have a spouse or partner who is not fully utilising their tax allowances, this could be an effective strategy for taking home more of your limited company earnings. By transferring company shares to the spouse/partner, you would be taking advantage of their unused dividend allowance and lower tax bands. So, if you think this could apply to you and need assistance with making your spouse a shareholder, then get in touch with us at Graham Wood.
5. Explore Employee Benefits and Perks
Instead of increasing salaries or dividends, limited company directors might consider providing themselves with tax-efficient benefits such as:
- Private healthcare
- Electric car salary sacrifice schemes
- Director’s loan repayment strategies
These options can reduce taxable income while still offering personal financial benefits.
6. Retain Profits Within the Business
If you, the director, do not require immediate access to all company profits, leaving funds within the business rather than withdrawing them as dividends can be a strategy to defer tax liabilities. These funds can be reinvested into business growth or used for future expansion.
Our tax planning experts at Graham Wood are experienced with reviewing accounts. And, understanding the best strategies for Limited Company Directors is what we do best. So, reach out to us, either by popping into our office in Hyde or contacting us here.
Make the Most of Your Limited Company Earnings
The reduction of the dividend allowance to just £500 presents a challenge for many limited company directors. This makes it more expensive to extract profits in a tax-efficient way. With additional pressures, such as increased corporation tax, business owners must be proactive in adjusting their remuneration strategies.
Working closely with an accountant to explore tax-efficient income strategies, pension contributions, and other alternatives is essential for navigating these changes successfully. While the landscape for small business taxation is becoming more complex, careful planning can still ensure financial efficiency and long-term success.
For help with reviewing your tax strategy, get in touch with Graham Wood Accounting today. We provide expert advice on tax planning and business structuring.
