If you run a limited company and pay yourself through dividends, contractor dividend tax for 2025/26 is charged at 8.75% in the basic rate band, 33.75% in the higher rate band, and 39.35% in the additional rate band, after a £500 tax-free dividend allowance. The basic and higher rates rise by two percentage points from 6 April 2026. You report and pay the tax through Self Assessment, and dividends only count as dividends if your company actually has the profit to pay them and you’ve followed the paperwork.
Why the Salary-Plus-Dividend Split Saves Tax
The saving isn’t really about the dividend rates themselves. It’s about National Insurance. Salary attracts employer NI at 15% above £5,000 and employee NI at 8% above roughly £12,570 from April 2025.1GOV.UK. Rates and Allowances: National Insurance Contributions Dividends attract neither.
Dividend rates are also lower than income tax rates at every band: 8.75% versus 20% at basic rate, 33.75% versus 40% at higher rate. The catch is that dividends are paid from post-corporation-tax profit, so the money has already been taxed once inside the company. Even so, corporation tax plus dividend tax usually comes out below income tax plus NI on an equivalent salary.
Setting Your Salary and Taking the Rest as Dividends
The standard approach for a sole director-shareholder is a salary of £12,570, which uses up the personal allowance without triggering income tax or employee NI.2GOV.UK. Income Tax Rates and Personal Allowances Your company pays around £1,136 of employer NI on the portion of that salary above £5,000, but the salary and that NI are both deductible against corporation tax.
On £50,000 of company profit for a sole director with no other income, at the 19% small profits corporation tax rate, the figures work out roughly like this:
- Salary of £12,570, no income tax, no employee NI, roughly £1,136 employer NI
- Corporation tax at 19% on about £36,294 of remaining profit, roughly £6,896
- Distributable profit of about £29,398
- Dividend tax: £500 tax-free, then 8.75% on £28,898, roughly £2,529
- Total tax burden of about £10,561 on £50,000
Taking the full £50,000 as salary would cost several thousand pounds more once employer NI, employee NI, and income tax are added up. That gap is why the split exists.
The £500 Dividend Allowance
Every individual gets a £500 dividend allowance each tax year, and it stays at £500 for 2026/27.3GOV.UK. Tax on Dividends Dividends within the allowance are tax-free, but they still count toward your total income when working out which band your remaining dividends fall into. It sits alongside your personal allowance, not inside it, so a fully used £12,570 personal allowance doesn’t cancel it out.
Dividend Tax Rates for 2025/26 and 2026/27
Once dividends exceed £500, your salary and any other income fill the tax bands first, and dividends stack on top. For the tax year running from 6 April 2025 to 5 April 2026:3GOV.UK. Tax on Dividends
- Basic rate band, £12,571 to £50,270: 8.75%
- Higher rate band, £50,271 to £125,140: 33.75%
- Additional rate, over £125,140: 39.35%
From 6 April 2026, the basic rate becomes 10.75% and the higher rate becomes 35.75%. The additional rate is unchanged at 39.35%. These are the first dividend rate rises since April 2022. A contractor drawing £37,700 of basic rate dividends will pay roughly £740 more per year under the new rates.
How Other Income Changes What You Pay
Your dividend rate depends on your total income, not just your dividends. With a £12,570 salary and nothing else, the full £37,700 basic rate band is available for dividends at 8.75%. Add £20,000 of rental income and £20,000 of that band is gone before your dividends even arrive, pushing a chunk into the 33.75% band.2GOV.UK. Income Tax Rates and Personal Allowances Contractors with rental property, savings interest, a second job, or a partner’s shareholding in the company need to model total income before deciding how much to distribute. Retaining profit in the company for a later year is often the answer when other income is unusually high.
Making a Dividend Legal
Moving money from the company account to your personal account is not, by itself, a dividend. Two things have to be true.
The company must have enough distributable profits to cover the payment, meaning accumulated realised profits minus accumulated realised losses, with corporation tax accounted for first. Pay a dividend the company can’t support and it is unlawful. A shareholder who knew, or had reasonable grounds to believe, that it was unlawful must repay it, and because most contractor companies are close companies, HMRC will treat the payment as a loan to the shareholder and apply the section 455 charge.4GOV.UK. Company Taxation Manual – CTM15205
You also need to declare the dividend properly. Hold a directors’ meeting, keep minutes even if you are the only director, and produce a dividend voucher for each payment showing the date, the company name, the shareholder’s name, and the amount.5GOV.UK. Taking Money Out of a Limited Company The voucher is your evidence at tax return time and if HMRC opens an enquiry. Monthly transfers without vouchers are a problem waiting to surface.
IR35: When the Strategy Doesn’t Work
The salary-and-dividend approach assumes your contracts sit outside the off-payroll working rules. If a contract falls inside IR35, the fee payer deducts income tax and employee NI from your fees before your company sees them, and employer NI is paid to HMRC on top.6GOV.UK. Understanding Off-Payroll Working (IR35) The dividend advantage disappears for that contract because the deductions mirror employment taxation.
Who decides your status depends on the client. Medium and large private sector clients and all public sector clients make the determination themselves. If your client is a small private sector business, your own company makes it. Determinations are contract by contract, so you can have some engagements outside IR35 where dividends work and others inside it where they don’t.
Reporting Dividends and Paying the Tax
Dividend tax goes through Self Assessment. If you haven’t filed before, register with HMRC by 5 October following the end of the tax year in which you received the dividends. The online return and payment are both due by 31 January after the tax year ends, so for 2025/26 that is 31 January 2027.7GOV.UK. Self Assessment Tax Returns: Deadlines
If your dividends are within the £500 allowance and you have no other reason to file, you don’t need to report them. Between £500 and £10,000 of dividends, you can file a return or ask HMRC to collect the tax through your PAYE code. Above £10,000, a return is mandatory.8GOV.UK. How to Report Tax on Dividends
Payments on Account
Once your Self Assessment bill exceeds £1,000, HMRC requires payments on account toward next year’s liability. Each payment is half of the previous year’s total tax, due on 31 January and 31 July.9GOV.UK. Understand Your Self Assessment Tax Bill: Payments on Account
Your first year of dividends is the one that hurts. On 31 January you pay the full tax bill for the year just finished plus the first payment on account for the year in progress, so roughly 150% of a normal year’s tax leaves your account at once. Set money aside from the moment dividends start. If your income later drops, you can apply to reduce payments on account, but HMRC charges interest if you reduce them below what you actually end up owing.