In the UK, dividends paid on shares held outside of an ISA or pension are taxable. However, every taxpayer has a tax-free dividend allowance, which allows them to receive a certain amount of dividend income before tax is due.

The dividend allowance for the 2022/23 tax year is £2,000. This means each taxpayer can receive up to £2,000 in dividends tax-free. Any dividends received above this amount will be subject to tax.

The dividend allowance applies per taxpayer, not per shareholding. So, if you hold shares across multiple shareholdings or investment accounts, the total dividends from all holdings are added together when determining how much of your allowance you have used.

The tax rates on dividends above the allowance are:

• Basic Rate: 8.75%
• Higher Rate: 33.75%
• Additional Rate: 39.35%

These rates include the notional 10% tax credit attached to dividends. The actual tax deducted depends on your income tax band. As the dividend allowance is a ‘use it or lose it’ allowance, shareholders need to make the most of it each tax year. Here are some tips on how to maximise your tax-free dividend income:

Hold Shares in a Tax-Efficient Account

The easiest way to receive dividends tax-free is to hold your shares within a Stocks and Shares ISA. All income and gains generated within an ISA are exempt from tax. So, your full dividend allowance is preserved for other shareholdings outside an ISA. If you don’t utilise your full ISA allowance each year, holding some or all shares in an ISA can help maximise tax-free income. It’s particularly beneficial for higher-rate taxpayers who would otherwise lose a third of dividend income above the allowance to tax.

Consider the Timing of Dividend Payments

The time for paying dividends from your company will fall within the same tax year. For example, bringing forward dividend payments normally made in April to March or pushing back October payments to November. This allows you to group dividend payments and maximise the use of the annual allowance.

Provided a company has sufficient reserves available, the directors can decide payment timing. Just be aware of rules about long gaps between dividend payments, which could lead to further tax charges.

Make Use of a Spouse’s Allowance

If you have a spouse with minimal or no other dividend income, consider transferring some shares into their name. This doubles the amount of tax-free dividend income available to your family.

On transfers between spouses, there is normally no capital gains tax to pay. So, this strategy does not incur an immediate tax charge. But seek advice to ensure it does not breach rules against transferring assets to a spouse to avoid tax.

Invest in Dividend Paying Shares

Investing in shares of companies that pay regular dividends is an obvious step to generating dividend income. Focus on established FTSE 100 companies, as these tend to have solid underlying profits capable of sustaining dividends.

Always ensure dividend yields look sustainable based on the company profits and cash flow. Abnormally high yields can be a red flag of an upcoming dividend cut.

Reinvest Dividends

When dividends are received on shares held outside an ISA, reinvesting them to buy more shares can grow your future dividend income. Provided you stay within the dividend allowance each year, there is no immediate tax to pay on the dividends.

By using dividends to buy more shares automatically, you can steadily build up your holdings overtime on a tax-efficient basis. Over the long run, the power of reinvesting compounds to accelerate portfolio growth.

Use Dividend Reinvestment Plans

Many companies offer dividend reinvestment plans (DRIPs), which allow shareholders to reinvest dividends automatically. This provides a convenient way to grow your holdings over time by ploughing dividends into additional shares.

Some companies provide the shares for reinvested dividends at a market price discount, enhancing the compounding effect. Just be mindful of trading fees charged on automatic dividend reinvestments.

Claim Tax Relief on Initial Purchase

An often overlooked tactic is claiming tax relief on the original purchase of shares. When you buy company shares, the stamp duty and broker fees involved are treated as deductible expenses.

You can claim tax relief by deducting these costs from your total dividends received during the tax year. This provides a small offset against the tax otherwise due on dividends above the allowance. Every little saving helps when investing for dividends. But ensure you keep records of your original share purchase costs to back up claims for tax relief.

The tax-free dividend allowance provides a significant tax break for UK shareholders. However, planning and structuring your shareholdings in a tax-efficient way to utilise them fully requires planning and structuring them. Seeking professional tax advice can help maximise the use of your dividend allowance. Contact our specialist tax advisors for tax planning and more information on personal tax planning.