In the budget, could the dividend tax almost double?

Investors and self-employed directors who receive income from company shares—including pensioners—would be negatively impacted if the proposed increase in dividend tax is implemented

Chancellor Rachel Reeves is said to be eyeing an increase to dividend tax in the Budget to bring it more in line with income tax, in what would be a blow to some business owners and investors.

Investors who purchase dividend-paying stocks and shares outside of an ISA or pension are required to pay dividend tax. Compared to income from earnings, this income is taxed differently.

However, many self-employed limited companies also pay themselves through a combination of salary and dividends from their own business profits, so they would also be subject to an increase in taxes, possibly amounting to thousands of pounds more annually.

According to the Telegraph, Reeves is considering increasing the basic rate of dividend tax in the Budget from its current level of 8.75 percent to something more akin to the basic rate of income tax, which is 20 percent.

The basic dividend tax rate should be raised to at least 16.5 percent, according to the Resolution Foundation, which has strong ties to the Treasury. The Telegraph stated that it was more likely that the 500 tax-free allowance provided to investors would be eliminated or reduced, along with a 4 percentage point increase in the levy.

According to reports, such a move could raise an additional nearly £2 billion.

Prior to the Budget, a Treasury spokesperson stated they would not comment on rumors.

Is the tax-free allowance for dividends ending?

Even the smallest retail shareholder would have to notify HMRC of their investments if the 500 tax-free allowance were eliminated.

In recent years, the allowance has undergone multiple reductions. It was cut in half from 1,000 in April 2024, but it was much higher at 5,000 when it was first introduced in 2016, just under ten years ago.

The higher and additional dividend tax rates, which are much closer to the corresponding income tax rates at 33.75 percent and 39.35 percent, respectively, are not anticipated to change.

The Conservatives last increased the dividend tax by 1.25 percentage points overall in 2022.

If a proposed increase in income tax is implemented, it is already anticipated that self-employed people and retirees will be worse off following the budget.

While a reduction in National Insurance would offset the income tax increase for employed workers, self-employed individuals would not benefit because they do not pay NI in the same manner. Similarly, no one who is older than the state pension age pays National Insurance.

What might the self-employed pay if dividend taxes were raised?

Increasing the dividend tax would probably result in self-employed directors paying thousands more in taxes annually, as they usually rely on dividends from their business to support themselves.

RSM, an accounting firm, was asked to do the math by BFIA.

The basic dividend rate is currently 8.75 percent. We consider a typical scenario in which a business owner receives a tax-free salary of £12,570, followed by dividends of £37,700 to exhaust the basic rate band and increase total income to £50,270.

Currently, the business owner would pay £3,255 in income tax annually. This is calculated by multiplying the 37,700 dividends (less the 500 dividend allowance) by the 8.75 percent dividend tax rate.

The annual tax burden for business owners would increase to 4,743 if the dividend tax rate were raised to 12.75 percent.

However, they might pay up to 6,138 in income tax annually, and there are rumors that the dividend tax rate could increase to 16.5 percent.

Therefore, there would be an annual increase in income tax of 1,488 if the dividend tax rate were raised from its current basic level of 8.75 percent to 12.75 percent. The additional tax burden on business owners would increase by 2,883 annually at the 16.5 percent rate.

Chris Etherington, a private client tax partner at RSM UK, stated: "The total tax burden in the basic rate band would be essentially the same, regardless of whether profits were extracted as dividends or salaries, if the 16.5 percent basic rate for dividends was introduced.

The timing of tax payments would be different, though, as you would have to deal with higher corporation tax bills and income tax payments through self-assessment for dividends instead of monthly payments through PAYE for a salary.

Many people see the reduced dividend tax rate as a reward for the risks entrepreneurs take in order to boost the economy and create jobs. As a result, it may be extremely delicate to align the taxes on dividends and salaries.

But it's important to remember that at the higher and additional rates of income tax, the tax rates for dividends and salaries already closely match. A "