How much is the tax-free dividend allowance in 2023/24?

As a contractor, dividends are one of two ways you can pay yourself through a limited company -- the other being through the company payroll under PAYE.

And for the uninitiated, dividends are essentially a portion of the company’s profit, after tax, that is paid to shareholders. 

What is the tax-free dividend allowance?

Currently, HMRC allows individuals to receive a certain amount of dividend income before they start paying tax, known as the dividend ‘tax free’ allowance. As of 6th April 2023, when the 2023/24 tax year began, that annual tax-free dividend allowance was halved to £1,000.

The upshot is that more contractors will have to start paying tax on their dividend income in 2023/24, and for those who take dividends regularly, it's vital to be aware of the change and how it affects tax payments, writes Zeeshan Anwar, head of compliance at Dolan Accountancy.

How does the tax-free dividend allowance work for contractor limited companies?

The tax-free dividend allowance for the 2023/24 financial year has been halved from £2,000 (the year before) to £1,000. This means that any individual who receives over £1,000 in dividend income will be liable to pay tax on the excess of their marginal rate.

Dividends that arise within ISA and pensions are exempt from dividend taxation, due to the favourable tax-free growth nature of these investments. 

Once the amount of dividend income an individual receives reaches the dividend allowance, the level of tax you pay on this income depends on what level of total income you receive in any given tax year.

What are the dividend tax rates for 2023-24?

The dividend tax rates for tax year 2023/24, which runs from April 6th 2023 and ends on April 5th 2024, have remained unchanged from 2022/23, and are as follows:

How does dividend income impact your HMRC tax liability?

It’s essential to understand how your total taxable income, including dividends, affects your tax liability with HMRC.

One key aspect of this is when looking at your overall income (to determine your tax band), your dividend income always sits on top of all other forms of income. So, if for example your income is made up of salary, dividends, and bank interest, then your dividend income will also face the highest tax bands since it is always the last form of income to be used in the tax calculation.

The good news is that you won’t need to pay National Insurance contributions on your dividend payments. This is why lots of directors who are also shareholders tend to pay themselves using a combination of a small salary topped up with dividends, because it’s more tax-efficient.

Is the tax-free dividend allowance going to keep on shrinking?

Introduced in 2016, the tax-free dividend allowance originally stood at a significant £5,000! In 2018/19, the allowance was reduced to £2,000 where it remained for the following five years. 

Now at £1,000, this 90% reduction of the allowance over a six-year timespan is one of the most significant decreases of any UK tax during that period. At Autumn Statement 2022, chancellor Jeremy Hunt also announced a further reduction of the allowance to £500 – to take effect for the 2024/25 tax year.

Final thought

These reductions in dividend tax allowance could increase the tax pressure placed on investors who rely on dividends as a central source of income. They might also deter aspiring contractors from contracting professionally as a limited company. But by understanding the rules surrounding dividend payments, staying informed about changes in dividend tax rates, and heeding your accountant’s advice, you can still optimise your overall tax position.