How Are Dividends Taxed?

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So you’re thinking of doing business through a limited company? We don’t blame you – for lots of contractors and freelancers it’s the most tax-efficient way of working.

In our experience, one of the big differences between an umbrella and limited company is how you’re paid. You’re probably used to getting a weekly or monthly salary from your employer or client, but now you’ll be able to pay yourself a combination of salary and dividends.

We know that this might sound like double Dutch if you’re new to all this – but don’t worry! We’ve created a handy guide to explain how tax on dividends all works, leaving you to focus on what you do best – running your business.

What are company dividends?

A dividend is paid to shareholders out of the company’s post-tax profits. The amount they’ll receive is based on how much of the business they own – so you’ll get 100% of the cash if you’re the only one.

How are dividends calculated?

Now for the scientific bit. To start with, you’ll need to deduct all your company’s expenses (salary, accountancy fees etc) and other costs from your turnover. The next thing to take off is small business tax – leaving you with your final profit amount (known as retained profit in case you’re wondering).

If this has left you scratching your head a bit – don’t worry as help is at hand. If you join a specialist accountant, such as ourselves, they’ll be able to guide you every step of the way.

Are dividends taxed?

Put simply yes, dividends are taxed. However, they are taxed at a lower rate than your salary is.

How does HMRC levy tax on dividends?

OK, so now we’ve covered the basics, it’s time to crank it up a notch – bear with us! The amount of tax you pay depends on your overall taxable income. If your personal earnings remain within the basic rate (£37,500 for the 2020/21 tax year), the amount will be 7.5%.

If you earn less than the additional rate limit (£150,000), you’ll have the first £27,000 taxed at 7.5% and the rest at 32.5%. Anything above £150,000 is taxed at 38.1%.

You’ll also receive a dividend allowance. This lets you withdraw £2,000 tax-free, whatever your employment earnings are for the tax year.

The dividend allowance can also be combined with your £12,500 personal allowance to increase the amount of tax-free dividends you’re able to withdraw.


If you pay yourself a salary of £5,000, the remaining £7,500 of your personal allowance can be added to your dividend allowance. This means the first £12,500 of dividends will be tax-free.

All make sense so far?

How do I work out how much tax I owe?

To work out how much tax you’ll pay, you first of all have to factor in your dividend allowance. Anything left over will be taxed at the relevant rate band.


You pay yourself a salary of £8,788 and withdraw £32,000 in dividends.

Because you've only used £8,788 of your personal allowance, the remaining £3,712 can be added to your £2,000 tax free dividend allowance. This means that your first £5,712 of dividends will be tax-free.

The remaining dividends will be taxed at 7.5%, meaning you’ll be charged a total of £1,971.60 in income tax. This assumes this is your only income for the tax year.

What if I’m caught out by IR35?

If you’re caught out by IR35 regulations, you’ll receive a ‘deemed salary’ rather than draw dividends. You’ll also get a 5% allowance to cover the cost of running a limited company.

How can ClearSky Contractor Accounting help?

Congratulations on making it this far! We hope this explained how to calculate dividend tax, but if you’re feeling like you need to lie down after all that, help is at hand.

Our expert team will take all the hassle away for you and calculate your tax liability on your behalf. This means you can be certain you’re taking home the right amount, leaving you free to concentrate on what you do best.

We’ll be with you all the way through your career, whenever you need us. Whether it’s help with dividends, IR35 assistance, or submitting expenses claims, you can rely on ClearSky.

For more information, or to join us, please call 0800 032 5326 or email