Dividend stocks are great investments because they pay out regular income every year. The question is whether these dividends count as income or not (for tax purposes).
A dividend is a share of company profits paid out to shareholders. Companies usually pay dividends to their shareholders at least once per year. In some cases, companies also pay dividends quarterly or even monthly.
In today's blog post we will discuss the difference between capital gains and ordinary income when it comes to dividends. We will also look at how dividends can be taxed in the United Kingdom.
What Is a Dividend?
A dividend is the distribution of earnings from one company to its shareholders. The amount of the dividend paid out depends on how much profit the company has made during the year and what the board of directors decides to pay out.
Dividends are paid out to shareholders when a company wants to reward or thank shareholders for being invested in the company. When you own a share of a company, you literally own a percentage of that company. For this reason some see dividends as simply receiving your fair share of the profits that you technically own.
Not all companies decide to pay out dividends but there are many reasons why they do. Some companies may not be profitable enough to justify paying out any money at all while others may want to use their profits to invest in new projects or even buy back shares.
For example, Coca Cola pays their investors a dividend of 2.78% per year according to Google at the time of writing this. This means that for each of their shares currently valued at $63.38, an investor would receive approximately $1.76 each year (2.78% of $63.38).
Coca Cola doesn't pay this dividend out all at once. They, like many other companies pay their dividend quarterly. This means 4 times per year. So instead for each share of Coca Cola stock you would in fact receive $0.44 each quarter.
Although many companies pay their dividend quarterly, different time frames are in place for different companies. For example, Realty Income ($O) pays their dividend monthly.
What Is Dividend Tax?
A dividend is money paid out of a corporation’s earnings. If you are receiving dividends, you will likely pay some taxes on it. This happens because shareholders receive profits from companies in the form of cash payments. These dividends do not count towards your personal income, but rather against your dividend allowance.
Dividend tax is usually charged at different rates depending on how much you earn and where you live. It can be up to 40% in the United States.
Here in the UK we have a personal allowance as with most types of income. This can vary year-to-year. These personal allowances ensure while making less than a certain amount we won't pay any taxes. It is important to stay up to date each year as to how much dividend income you can make before exceeding your personal allowance.
Once you have exceeded your dividend allowance you will have to file a tax return or if your in the UK you can also register for a self assessment which essentially is the equivalent.
How Much Tax Do I Pay on Dividends in 2022/23?
In the UK for 2022/23, the current personal allowance is £2000. This means that if you make less than this then you won't pay any tax on your dividends. However, if you make more than this then you'll pay tax on them. The rate of tax varies depending on your circumstances.
The amount of tax you end up paying on your dividend income depends on which income tax rates you are in. For example, if you are a basic rate taxpayer on your income tax rates then you will pay 8.75% tax on your dividends.
If you are in the higher income tax band then you will pay 33.75% tax. Finally, if you are on the additional rate income tax band then you will pay 39.35% tax on your dividends.
Working Out Tax On Dividends
To help you understand how to work out what tax you will pay on your dividends, here's a quick example using the values above. First of all let's say I am in the higher rate income tax band. This means I will be paying 33.75% income tax.
Let's now say I made £4652.42 in dividends this year. Firstly I will take away my personal allowance of £2000. So that makes £2652.42 (£4652.42 - £2000). I then apply the tax amount to the new value.
33.75% of £2652.42 = £895.19 (Tax Paid)
You can see above we have worked out our tax to be paid as £895.19. This means the dividend income we keep would be whatever we have left from removing the tax.
£4652.42 - £895.19 = £3757.23 (After-Tax Income)
Where Can I Find More Information?
For more information on paying taxes on your dividends in the UK, check out the following website from the UK government:
https://www.gov.uk/tax-on-dividends
Here you can also register for a self assessment if you feel you need to begin paying taxes on your dividends.
Summary
So there you go! Hopefully this has helped answer your questions about dividends. As mentioned, to find out more information on paying taxes on your dividends then visit the site above provided by the government. If you enjoyed this blog post or found it helpful then consider sharing it on social media. Also feel free to leave any feedback in the comment section below.
Thanks for Reading 😀
FAQ
What is dividend tax?
If you own shares in a company, there are two ways you can earn money: from selling the shares if they grow in value or from dividends paid by the company if it chooses to distribute profits to shareholders.
Source: which.co.uk
Which dividend tax rates will I pay?
The general rule is that your tax rate depends on how much income and capital gains you've received in any given year.
Source: which.co.uk
How does the personal savings allowance work?
Banks and building societies do not deduct tax from savings interest. This means you receive your interest gross. There is also a personal savings allowance, which effectively means you can usually have some savings income tax free.
Source: litrg.org.uk
What is the dividend allowance?
Your dividend tax allowance is the amount you can earn tax-free from dividends. The dividend allowance in the UK for the 2022/23 tax year (6th April 2022 to 5th April 2023) is £2,000. This allowance is in addition to your personal allowance of £12,500. That means you can earn a total of £14,500 in tax-free allowances; £12,570 from your personal allowance and £2,000 from your dividend allowance.
Source: raisin.co.uk
What is a dividend?
A dividend is money paid to shareholders out of a business's profits. Many company owners choose to pay themselves using a combination of both salary and dividend payments. This is because it can be more tax efficient than simply paying yourself through Pay As You Earn Paying tax on dividends depends on the income tax band you fall into.
Source: simplybusiness.co.uk