With Income Tax unlikely to change, is it worth altering your dividend-based salary strategy?

With Income Tax unlikely to change, is it worth altering your dividend-based salary strategy?

For business owners and directors, dividends may form a critical element of your salary strategy and tax planning, keeping your tax liabilities to a minimum.

To extract profit tax-efficiently from your business, you may use a combination of:

Dividends can be an excellent choice for business owners because they are taxed at a lower rate than earnings subject to Income Tax.

The tax is levied depending on your Income Tax band:

For this reason, many business owners choose to take a relatively low salary in addition to dividends, to stay in the Basic rate band and minimise tax on dividend payments.

Could dividend taxes change?

Dividends have been a growing target for HMRC in recent years, with the tax-free allowance falling steadily from £5,000 in 2016/17 to £500 in 2024/25.

Having pledged to avoid raising taxes on income, the Government may seek to levy further tax on wealth in the Autumn Budget instead, which could incorporate dividends.

The Government has various options, including:

Should you change your strategy?

If you have a typical tax-efficient profit extraction strategy, with a low salary and dividends, then this is likely to remain the best approach to optimising your tax liabilities – but this is highly dependent on whether tax rates on dividends remain the same.

If tax rates remain unchanged, any dividends will still be subject to a lower rate of tax than if they were taken as salary, even without a tax-free allowance.

However, a rise in rates could result in a significantly higher tax liability.

In this situation, you may consider another method of profit extraction, such as making additional pension contributions if you have not used your full tax-free pension allowance.

For advice on managing profit extraction, salary and dividends, please contact our team today.

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