Number of people paying dividend tax doubles in three years as tax cut hits small investors

The number of people expected to pay tax on dividends has doubled in three years as a cut in deductions hits small investors and the self-employed.

HMRC is expected to collect almost £18bn in dividend tax in 2024/25, with the number of those paying it having doubled since 2021/22.

Nearly 3.6 million taxpayers are expected to pay tax on their dividends this financial year, according to a Freedom of Information request made by investment platform AJ Bell.

Current dividend rules mean that investors do not have to pay tax on dividend payments they receive below the threshold for the tax year.

However, the tax-free threshold on dividends has been reduced in recent years, from £2,000 to £1,000 in April 2023, and then to just £500 from April 2024 for this tax year.

The rate at which they are paid is 8.75 percent for taxpayers with a basic rate, 33.75 percent for taxpayers with a higher rate and 39.35 percent for taxpayers with an additional rate.

This means that more people’s incomes are pushed over the thresholds, meaning that many basic rate taxpayers, who barely make it over the limit, will have to file a tax return even with minimal dividend income.

A fifth of all higher rate taxpayers are expected to pay tax on their dividends this tax year, with an average bill of £5,379, while additional rate taxpayers will pay £32,578 on average.

Basic rate taxpayers will pay an average of £385 this year, up from £780 three years ago, as more people with smaller dividends are forced to pay the tax.

Laura Suter, personal finance director at AJ Bell, said: ‘What’s particularly frustrating for some of these people is that they will have missed the dividend allowance, meaning they will now have to file a tax return for a negligible amount of tax.

‘The average dividend tax bill for basic rate taxpayers is £385, although many will pay much less than that and still have to fight with HMRC.

‘If we look at the average dividend tax bill over the years, we can see that more taxpayers with smaller portfolios have been forced to pay the tax.

‘In 2021-22, the average dividend tax bill for a basic rate taxpayer was £780, but this figure has now been reduced to £385, despite dividend tax rates increasing over this period.’

Frozen tax thresholds elsewhere are having a similar effect, pushing more taxpayers into higher brackets and even impacting retirees.

HMRC figures published in June revealed that more pensioners than ever are now paying tax on their income, rising from 7.85 million in 2023/24 to 8.51 million in 2024/25.

This means that there are now almost 9 million people aged 65 or over paying income tax, compared with 4.9 million in 2010/2011.

Half a million taxpayers will also receive a “tax demand” letter from the IRS.

Simple tax assessment letters will be sent to those who owe income tax that cannot be automatically deducted from their own income, owe HMRC £3,000 or more, or have to pay tax on their state pension.

An increase in interest rates also means that more people with modest savings could now also be subject to taxes on their income.

It will also be the first time many pensioners will receive a tax demand letter, because frozen thresholds mean their combined income from state and private pensions has taken them above the threshold.