Dividends are payments that limited companies can make to their shareholders (including you as the owner) if the business makes a profit. In other words, if you have money left over after paying your taxes, business expenses and debts, you can reinvest it or pay it to yourself as a dividend. This is called a dividend income.

This guide will help you understand dividend income by exploring:

  • How companies pay out dividends
  • What dividend income is
  • The main types of dividends
  • How you pay tax on dividend income
  • How often you can pay yourself in dividends
  • How Countingup can help

How companies pay out dividends

Limited companies have a number of shareholders who have invested in the company, including you as the owner. If you’re a one-person business, you’ll be the only shareholder.

Limited companies can only pay dividends if they have enough profit available. If your limited company has enough profit available, you pay out the dividends according to the number of shares each shareholder owns. For example, if a shareholder bought 30% of the company, they receive 30% of the dividends.

Note that sole traders, partnerships and LLPs (limited liability partnerships) can’t issue dividends because they don’t issue shares.

What dividend income is

Whether you’re the only shareholder or not, you can choose to pay part of your wages in dividends if you have enough profit. Many business owners choose to subsidise their salary with dividends since it’s more tax-efficient. You generally pay less tax on dividends than a salary, which we’ll explain more about later in this article.

You can also choose to reinvest the dividends into your business to support its growth. Perhaps you want to purchase new equipment or put the money towards research and development? If you’re the only shareholder in your limited company, it’s ultimately your choice where you invest your profits.

The main types of dividends

You have several options for what type of dividends to pay out. We’ve listed the main types of dividends below:

Cash dividends

The most common dividend, preferred by small companies. Generally paid directly into the shareholder’s account and allows shareholders to keep the money. 

Stock dividends

You can choose to pay investors with additional shares in your company, meaning they own more of the company and receive more dividends over time. Also, investors don’t pay Income Tax on stock dividends.

Special dividends 

Typically issued to distribute profits you’ve made over several years or that you have no immediate need for. Special dividends don’t repeat like cash or stock dividends. You can use special dividends to improve shareholder confidence by showing trust in the company’s long-term value.

How you pay tax on dividend income

You don’t pay tax on dividend income that falls within the Personal Tax-Free Allowance, which is £12,570 in 2021/22. Shareholders (including you) also get a Dividend Allowance of £2,000 in the 2021/22 tax year. 

If you subsidise part of your salary with dividends, you’ll be taxed less than if you just take the entire amount as a salary. Shareholders start getting taxed on dividends once they’ve used up their Personal Allowance and the tax-free Dividend Allowance. 

These are the tax rates for dividends:

  • Basic-rate taxpayers pay 7.5%
  • Higher-rate taxpayers pay 32.5%
  • Additional-rate taxpayers pay 38.1%.

For Scottish taxpayers, Income Tax is based on the Scottish Income Tax Rates, but you still need to calculate and pay dividends tax using the UK tax rates and thresholds.

Can I get an example of how this works?

Of course! Let’s say you’re the director of a limited company where you’re also the only shareholder. Over the last two years, you’ve made a £1,000 profit after paying your taxes, expenses and debts. You decide to pay yourself this amount as dividends.

Since you own 100% of the company shares, you also receive 100% of the dividend payments. Since the £1,000 you pay yourself doesn’t exceed the Dividend Allowance, you don’t have to pay any tax on your dividends. However, when you fill out your Self Assessment tax return for the year the dividends are due, you must declare the dividend payment.

How often you can pay yourself in dividends

You can choose to pay yourself dividends as often as you like, provided you have enough profits to do so. However, it’s usual practice to pay out dividends monthly or quarterly. 

When paying dividends, you need to make sure you have enough money to pay yourself and meet your future outgoings (bills, rent, mortgage, rent, etc.). Therefore, it’s essential to stay on top of your bookkeeping to keep track of money leaving and entering your business.

If you run a limited company as a contractor, the rules are a little different. It’s important to be aware that you can’t take out dividends on contracts that fall within IR35. All income you make from IR35 contracts must be taken out as a salary.

Save time on financial admin with Countingup

By setting up a Countingup business current account, you can easily manage all your financial data in one place. The app comes with free built-in accounting software that automates the time-consuming aspects of bookkeeping and taxes. 

You can view real-time insights into your business finances, profit and loss statements, tax estimates and invoices. All this will help you manage your dividend income and know how much money to set aside for tax.

You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward!
Download the Countingup app to apply for your business current account in minutes. All you need is proof of ID and a selfie. Download the app here.

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