2024/25 Dividend Tax Calculation. Two Practical Examples

Today, we are going to take a look at two illustrative examples to help explain the process of completing a dividend tax calculation for the 2024/25 tax year. This follows on from our popular 2022/23 Dividend Tax Calculation. Two Practical Examples article.

The reason behind this is the popularity of our dividend and salary tax calculator available on our website, alongside numerous other calculators found online designed to estimate your tax liability from dividend income. Despite their usefulness, these tools often fall short in accurately reflecting the complexity of how dividends are taxed when considering other income streams. Previously, the tax structure was such that dividend income would invariably be stacked on top all other forms of income, subjecting it to the highest tax rates through the income tax bands. Recent adjustments, however, allow for a more nuanced approach where the allocation of the personal allowance in your dividend tax calculations can be optimized, aiming to lower your overall tax bill significantly.

Most personal tax filing software will do this for you automatically when you come to file your UK self-assessment tax return, so it does sort itself out eventually, but what we’re looking at today is how to calculate your dividend tax due before your tax return has been prepared.

For those lucky contractors who already use our accounting service, they will know that our Joy Pilot accounting software automatically does their dividend tax calculation for them at any point in the tax year. This is one of the benefits of our Joy Pilot software, a limited company contractor always knows the liability for only all company taxes (corporation tax, PAYE/NIC, VAT), but also dividend tax on a personal level.

Our previous discussions on Paying Tax on Dividends in the 2024/25 tax year have shed light on the mechanics behind dividend taxation. Yet, nothing solidifies understanding as well as practical, worked examples.

In the dividend tax calculation illustrations here, we’re going to scrutinize two distinct scenarios. The first centres on a typical limited company contractor who draws a salary of £9,096 yearly from their limited company and receives £45,000 in dividends. The second scenario focuses on a full-time employee with a £50,000 annual salary complemented by £6,000 in dividend income. This latter scenario, in particular, will highlight the nuanced interaction with the personal allowance.

Scenario 1 – £9,096 salary, £45,000 dividends

In this scenario, we consider a limited company contractor who has taken a salary of £9,096 and awarded themselves £45,000 in dividends for the 2024-25 tax year. This blend of a minimal salary and significant dividends is a preferred strategy among limited company contractors, leveraged primarily because the salary portion is a tax-deductible business expense, thereby effectively tax-exempt within certain thresholds. The dividends, in contrast, are subject to taxation at varying dividend tax rates as dictated by the current tax bands.

Following the deduction of the salary from the personal allowance, there remains a portion of this allowance to offset against the dividend income, in addition to the tax-free dividend allowance. This sets the stage for our dividend tax calculation.

So let’s run through a real life dividend tax calculation example now using 2024/25 HMRC tax rates and bands.

Given the personal allowance for the 2024-25 tax year of £12,570—the salary of £9,096 is subtracted first. This leaves £3,474 of the personal allowance usable for dividend income.

So, the taxable dividend amount is calculated as £45,000 minus £3,474, equalling £41,526.

The next portion of dividends falls into the basic rate tax band, and any overflow into the higher rate tax band, considering first the tax-free dividend allowance of £500. 

So in this case the summary of our dividend income tax calculation is;

Personal allowance 3,474 (untaxed)

Basic rate dividend income, 500 @ 0% = 0 (this is the dividend allowance)

Basic rate remaining dividend income, 37,200 @ 8.75% = 3,255

Higher rate dividend income 3,826 @ 33.75% = 1,291

Total dividend tax liability for 2024/25 = £4,546

Below you can see how the income is spread across the first three income tax bands.

This simplified example aims to illuminate the fundamental process behind dividend tax calculations. Should the contractor have alternative sources of income, such as rental earnings, it’s important to consider how these additional income streams might elevate the overall tax rate applicable to the dividends, often pushing more of this income into higher tax brackets.

Scenario 2 – £50,000 salary, £6,000 dividends

In our next scenario, we explore the situation of a full-time employee with an annual salary of £50,000, routinely taxed through their employer’s payroll system. Ordinarily, such an individual wouldn’t need to file a UK personal tax return since their tax is already handled via PAYE (Pay As You Earn).

However, introducing £6,000 of dividends changes the equation. This dividend income could stem from various sources, such as investments or ownership in a private limited company, but for tax calculation purposes, the source is irrelevant. The critical point here is that with dividend income exceeding the dividend allowance of £500, this employee must now file a personal tax return.

Typically, you would expect the salary to fully consume both the personal allowance and the basic rate income band, placing any dividend taxation squarely in the higher rate bracket. Yet, with the flexibility allowed in allocating the personal allowance, especially with HMRC-approved tax return software, there’s room to optimise.

For optimal tax efficiency, all salary income would remain taxed within the basic rate limit, thereby relegating the dividend income to the higher tax band, with the initial £500 being tax-free due to the dividend allowance.

In this instance, an allocation of £12,300 from the personal allowance is applied towards the salary, alongside the complete basic rate tax band of £37,700, accounting for the entire salary amount of £50,000.

Consequently, for the dividend income, there’s £270 of the personal allowance available (reflective of £12,570 minus £12,300 used for the salary), leaving no basic rate band for dividends and pushing all additional dividend income into the higher rate tax band.

So, the dividend tax calculation would break down as follows:

– Personal allowance for dividends: £270 (untaxed)

– Basic rate dividend income: £0 (fully used by salary)

– Higher rate dividend income, 500 @ 0% = 0 (this is the dividend allowance)

– Higher rate remaining dividend income, 5,230 @ 33.75% = 1,765

– Total dividend tax liability for 2024/25 = £1,765.

Below you can see how the income is spread across the first three income tax bands.

This scenario unveils an intriguing tax dynamic where the assumed salary, taxed under the conventional 1257L tax code, would have usually seen £7,486 deducted by the employer under the assumption of full personal allowance utilisation for the salary. Yet, with dividends now in play and employing an optimized approach, the cumulative tax on the salary would adjust to £7,540.

This adjustment implies that the employee’s overall personal tax liability, combining both the dividend tax and the increment on salary tax, equates to approximately £1,819. This calculation brings clarity to the overall tax situation of the employee, encapsulating the consequences of receiving £6,000 in dividends in a comprehensive manner.

Summary

The intricacies involved in the taxation of dividends, as illustrated through these scenarios, highlight the inadequacy of simply relying on an online dividend tax calculator to accurately predict tax liabilities. The interplay of various factors—such as the allocation of personal allowance, the interplay between salary and dividends, and the strategic optimisation of tax band can be very useful in determining the final tax due on dividend income.

Especially evident from scenario two, the flexibility in deploying the personal allowance can impact the outcome of a dividend tax calculation (though this impact is not as great that’s what it was when the dividend allowance was £2,000).