Dividend Tax Rates
Dividends are an attractive source of income for investors. However, knowing what tax rates you may be paying them is essential. A financial advisor can help you understand how dividends affect your tax bill.
The tax rates on ordinary dividends depend on your filing status and tax bracket. However, high-income earners must pay an additional 3.8% surtax on their investment income.
What are Dividend Tax Rates in the U.K.?
The United Kingdom had a system of dividend tax rates that applied to individuals receiving dividends from shares they hold in companies. The rates for dividend taxation in the U.K. were structured as follows:
- Dividend Allowance: A tax-free dividend allowance means individuals can receive a certain amount of dividends without taxing them. The dividend allowance is £2,000 per tax year.
- Basic Rate Taxpayers: For individuals whose total income, including dividends, falls within the basic rate tax band, the dividend tax rate is 7.5%. This rate is applied to dividend income above the tax-free dividend allowance.s
- Higher Rate Taxpayers: For individuals with total income, including dividends, that fall within the higher rate tax band, the dividend tax rate is 32.5%. This rate is applied to dividend income above the tax-free allowance and up to the higher rate threshold.
- Additional Rate Taxpayers: For individuals with total income, including dividends, in the additional rate tax band, the dividend tax rate is 38.1%. This rate applied to dividend income above the higher rate threshold.
- Dividend Tax Credits: Dividend Tax Credits: Dividends are subject to a notional tax credit. This credit accounted for the corporation tax already paid by the company distributing the dividends. However, individuals do not receive this credit as a tax refund, but it helps reduce the overall tax liability on dividends.
| HMRC VAT RATES 2023 |
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% of VAT |
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| Standard rate |
20% |
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| Reduced rate |
5% |
Some goods and services, eg children’s car seats and home energy
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| Zero rate |
0% |
Zero-rated goods and services, eg most food and children’s clothes
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Qualified Dividends
A company can reward its shareholders by paying out dividends, a portion of the corporation’s earnings. These dividends are taxed at different rates, depending on the dividend type. Qualified dividends are taxed at lower rates than ordinary dividends, which are taxed at regular income-tax rates. The qualified dividends tax rate varies from 0% to 20%, depending on your federal income tax bracket. Investors in higher income brackets should pay attention to this difference, which could significantly reduce their overall tax bill.
Qualified dividends are considered a long-term capital gain and are subject to much lower tax rates than ordinary income. This means investors in the top two income tax brackets can save up to 20% on their taxes by investing in qualifying dividends.
To qualify for the lower rate, a dividend must be paid by a domestic U.K. corporation, a foreign corporation listed on an established U.S. stock exchange, or a pass-through entity such as a master limited partnership (MLP). However, the payouts from some types of investments do not qualify for this lower rate, such as real estate investment trusts and MLP distributions.
The dividends from growth-oriented companies, such as Tesla or Amazon, are often called qualified dividends because they reinvest the net profits in the business instead of distributing them to shareholders. This strategy allows the companies to grow faster and generate a higher return on invested capital.
Ordinary Dividends
Ordinary dividends are a portion of company earnings that companies distribute to shareholders. They are typically paid regularly and can be a great way to invest your money. However, it is essential to understand how ordinary and qualified dividends differ. The main difference is that ordinary dividends are taxed at your regular marginal income tax rate, while qualified dividends are taxed at lower capital gains rates. Investors can usually tell if their dividends are ordinary or qualified by looking at the 1099-DIV form they receive each year.
Generally, ordinary dividends are taxed at the ordinary income tax rate, which currently maxes out at 37%. However, qualified dividends are taxed at lower rates, saving you significant taxes. Qualified dividends are defined as dividends received from domestic corporations or qualified foreign corporations that have met special requirements issued by the IRS. The requirements include a holding period and unhedged transactions.
Investors should also know the Net Investment Income Tax (NIIT), an additional 3.8% tax on dividends and other investment income. This tax applies to those whose modified adjusted gross income exceeds certain thresholds based on filing status and total income. To avoid the NIIT, investors should consider keeping their income low by taking advantage of medical expenses, retirement contributions, and mortgage interest deductions.
Foreign Dividends
A foreign dividend is a portion of the profits a company based outside your country distributes. You can get this type of income from international mutual funds or directly from foreign-based corporations.
However, you can offset some of the withholding taxes deducted from your dividends by claiming a credit or deduction on your tax return. The tax credit is usually the better option because it reduces your tax bill dollar-for-dollar, while a deduction only reduces your taxable income.
For example, if you receive a net dividend from an Irish corporation, Ireland will withhold 15% tax. This will add up to 52% tax, including 40% income tax, 4% PRSI, and 8% USC. The good news is that you can use a non-refundable foreign tax credit to offset the taxes withheld from your dividends.
Another strategy for lowering foreign taxes on dividends is to keep your foreign stocks in a taxable account instead of an investment vehicle like an IRA. This can help you avoid double taxation if you hold your foreign stocks in an IRA. However, this strategy may be less effective for those with high foreign dividends.
Dividend Withholding Taxes
A tax-free dividend allowance allowed individuals to receive a certain amount of dividend income without paying any tax on it. The dividend allowance was £2,000 per tax year.
- For individuals whose total income, including dividends, falls within the basic rate tax band, the dividend tax rate is 7.5%. This rate applies to dividend income above the tax-free dividend allowance.
- If your total income, including dividends, was in the higher rate tax band, the dividend tax rate was 32.5%. This rate applies to dividend income above the tax-free allowance and up to the higher rate threshold.
- For individuals in the additional rate tax band, the dividend tax rate is 38.1%. This rate applied to dividend income above the higher rate threshold.
It’s important to note that dividends were subject to a notional tax credit. This credit accounted for the corporation tax already paid by the company distributing the dividends. However, individuals did not receive this credit as a tax refund, but it helped reduce the overall tax liability on dividends.
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