Do You Pay Tax On Dividends That Are Reinvested? (2024)

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When you reinvest your dividends, you may wonder if you’re paying taxes on that income. The answer is: it depends. If the company pays out cash dividends, you will owe taxes on those payments even if you decide to reinvest the cash received. If however, the company reinvests your dividends to purchase additional shares, you will not owe taxes until you sell those shares.

At that point, you will pay capital gains taxes on the difference between the price you paid for the shares and the price you sold them for. So, if you’re looking to defer taxes on your dividend income, reinvesting is a good option. However, keep in mind that you will eventually have to pay taxes on those earnings.

If you receive dividends, you may be wondering what to do with them when you receive them. Should you cash them out or reinvest them and what are the tax implications of each option? Read on to find out.

What Are Dividends And How Are They Paid To Shareholders?

A dividend is a sum of money paid per share by a company to its shareholders out of its profits (or reserves). Dividends are usually paid twice a year (known as an interim and final dividend), but can also be paid quarterly or as a special dividend. Investors can choose to reinvest their dividends or take them in cash.

To receive a dividend, you must own shares in the company on the ‘record date’. This is usually two business days before the payment date and is the date on which the company determines who its shareholders are. Once you have been registered as a shareholder on the record date, you will receive a payment on the specified payment date. Dividends are normally paid directly into your bank or building society account, although some companies still issue paper cheques.

If you sell your shares before the record date, you will not receive that dividend payment. Similarly, if you buy shares after the record date (but before the payment date) you will not receive the current dividend payment but will become entitled to any future dividends declared by the company.

Tax On Dividends

When you invest in a company, you may be entitled to receive dividends payments that are shares of the company’s profits. These payments can be a helpful source of income, but it’s important to understand how they are taxed.

Simply put, when a fund or shares are held in a tax-efficient account like an Individual Savings Account (ISA) or Self-Invested Personal Pension (SIPP) there’s no income tax, capital gains tax (CGT) or dividend tax to pay.

When held outside one of these wrappers, your investment is subject to income tax, capital gains tax (CGT) and dividend tax rules.

What you need to know:

• Everyone has a personal £2000 dividend tax-free allowance
• If receiving more than £2000 in dividends, the tax amount owed depends on your personal tax bracket. So so if you’re a basic rate taxpayer, you’ll pay tax at 20%, rising to 40% if you’re a higher rate taxpayer and 45% if you’re an additional rate taxpayer.
• When you sell your shares, you could be liable to pay capital gains tax on any amount earned over your capital gains allowance of £12,300 for the tax year 2022-2023.
• Reinvested dividends are treated as if you actually received the cash and are taxed accordingly. This means that you will owe taxes on the reinvested dividends when you eventually sell your shares.

Knowing how dividends are taxed can help you make more informed investment decisions and maximise your earnings.

Tax On Reinvested Dividends

Many investors choose to reinvest their dividends back into the company via a ‘dividend reinvestment plan’ (DRIP) or Automatic dividend reinvestment (ADR). This allows them to buy more shares in the company without having to pay any dealing charges.

Most companies offer some form of DRIP or ADR, although there may be some restrictions (such as only being available to UK residents). You should check with the company concerned if you are interested in reinvesting your dividends in this way.

If you receive your dividend payment as cash, then reinvest it yourself, these reinvested dividends are treated as if you received the cash and are taxed at your ordinary marginal income tax bracket rate in line with the rates shown in the cash dividends for the tax year 2022- 2023 section below.

If however, the company reinvests your dividends to purchase additional shares such as through a DRIP, you will not owe taxes until you sell those shares. At that point, you will pay capital gains taxes on the difference between the price you paid for the shares and the price you sold them for.

Capital Gains On Reinvested Shares

When you want to sell your shares in a company, (reinvested or not), you may have to pay Capital Gains Tax. If you make a profit, also referred to as a ‘gain’ on the price that you paid for the shares, then you can check how much Capital gains tax is due using HMRC’s capital gains guidance pages.

Your gain is the amount that you paid for the shares minus the amount that you sold them for, any associated costs, and any tax reliefs due. You can use HMRC’s capital gains calculator to work through each step and make calculating your capital gains as easy as possible.

Be aware that capital gains tax is not payable in the following dividend scenarios:

• If you gift the shares to your wife/husband/civil partner or charity
• shares you’ve put into an ISA or PEP
• shares in employer SIPS
• UK government gilts (including Premium Bonds)
• Qualifying Corporate Bonds
• employee shareholder shares – depending on when you got them

There are also some circ*mstances to be aware of that affect the price you should use for calculating the gains made. This includes if you have given the shares away, gifted them, or owned them before April 1982, you should use the current market value to determine your capital gain tax liability.

Other circ*mstances that require alternative calculations include if you bought shares through an investment club, jointly with someone else, after a company merger or takeover, employee share scheme.

Capital Gains Rates For Tax Year 2022-2023

When you have worked out the value of your capital gains, you can calculate whether you will pay 10 or 20% capital gains tax on any amount over your capital gains tax-free allowance based on your income tax bracket. The capital gains tax-free allowance is £12,300 for the tax year 2022-2023.

Basic Rate Taxpayer Calculations

• Total up your taxable income – this is all income minus your personal income tax-free allowance of £12,570 for the tax year 2022/2023
• Work up your taxable gains using the calculator on HMRC’s website
• Deduct your £12,300 capital gains tax-free allowance from your total taxable gains
• Add this amount to your taxable income
• If the total falls within the basic income tax band, you will pay 10% tax on the capital gains, but if it falls higher than the basic income tax band, you will pay 20% on any amount over the basic tax rate.

Tax on Cash Dividends For Tax Year 2022 – 2023

If the company pays out cash dividends, you will owe taxes on payments made that take your income over your personal allowance. This will be taxed at an amount based on your ordinary marginal income tax bracket rate.

In addition to a personal allowance, you also get a dividend allowance each year, (£2000 for the tax year 2022-2023), and you only pay tax on any dividend income above the dividend allowance.

Dividend Tax Due Based On Income Tax Bracket

To work out which tax band you fall into, you should add your total dividend income to your other income. You may pay tax at more than one rate.

For example; If you receive £5000 in dividends on top of your £25,000 income from wages in the 2022 – 2023 tax year, you would have a total income of £29,000.

After you have deducted your personal allowance of £12,570, this leaves you with a taxable income of £17,000.

As this figure falls within the basic rate tax band, you would pay:

• 20% tax on £22,000 of wages
• No tax on £2,000 of dividends due to the dividend allowance
• 8.75% tax on £3,000 of remaining dividends.

How Do You Pay Tax Owed On Dividends?

If you receive between £2,001 and £10,000 in dividends and already have to fill out a self-assessment tax return, you can include the dividend income in your self-assessment return.

If you don’t already self-declare this way, you can let HMRC know about the dividends up to £10,000 over your tax-free allowance, and they can change your tax code. You can do this by phone or post, and this will mean that the tax owed will be taken from your wages or pension.

If you earn over £10,000 in dividends you will need to fill in a self-assessment tax return and submit it by the following tax year that you received the income.

How To Reinvest Dividends Efficiently

A dividend reinvestment plan, also known as a DRIP, is an investment strategy that allows shareholders to automatically reinvest their dividends in additional shares of stock, rather than receiving the cash payment due. This has the effect of increasing the shareholder’s ownership stake in the company over time.

Dividend reinvestment plans are particularly beneficial for long-term investors, as they can compound returns significantly. While there are many different types of dividend reinvestment plans available, they all share one key advantage: they offer a way to invest without incurring brokerage commissions.

For this reason, dividend reinvestment plans can be an attractive option for investors who are looking to build a large position in a company over time. While there are some risks associated with investing in a company through a dividend reinvestment plan, these risks are generally outweighed by the potential benefits.

Remember though, when you eventually come to sell your shares, you will be liable to pay capital gains tax at the rates outlined in this article above on the difference between the price you paid for the shares and the price you sold them for.

Are Dividends Taxed At Corporate Or Individual Level?

In the UK, dividends are subject to two levels of taxation: corporation tax at the corporate level and income tax at the individual level. Corporation tax is charged on a company’s taxable profits, which include dividends paid to shareholders.

Income tax is charged on an individual’s total income, including dividends received from investments in shares. The rate of taxation depends on the individual’s personal circ*mstances and income tax band as outlined above.

There is no corporation tax due on dividends received by companies. This system of taxation ensures that companies are taxed on their profits before they distribute them to shareholders and that shareholders are then taxed on their income from dividends at their marginal rate of income tax.

What Are The Risks And Benefits Of Reinvesting Dividends?

Dividends are payments made by a corporation to its shareholder members. They are usually paid out quarterly and are often reinvested back into the company. While this can be a good way to grow your investment, there are some risks and benefits to consider before deciding to reinvest dividends.

Benefits

• reinvesting dividends allows you to compound your earnings. This means that the dividends you earn will not only be added to your original investment, but they will also earn dividends themselves. Over time, this can significantly increase the value of your investment.

• Dividends are considered taxable income, so if you reinvest them back into the company, you will not have to pay taxes on them until you sell your shares. This can be beneficial if you plan on holding onto your investment for a long period; however, if you need the cash now, you may want to consider taking the taxable income and investing it elsewhere.

• Reinvesting could allow you to reinvest in shares of a stock at a lower price, which can further increase your profits.

Risks

• It is important to remember that reinvesting dividends does not guarantee a profit; there is always the risk that the company’s stock price and dividend payments could fall, which would result in a loss.

• if the stock price falls, you may end up with less money than you would have if you had simply cashed out the dividend. Additionally, reinvesting dividends ties up your capital and prevents you from using it for other investment opportunities.

• Automatically reinvesting could mean you purchase shares at a higher value than you would otherwise have been comfortable doing so.

As with any decision related to investing, it is important to weigh the risks and benefits of reinvesting dividends before making a final decision.

Summary

Dividends are profits that a company pays to its shareholders out of its after-tax earnings. Shareholders must understand the tax implications of dividends that they receive from the shares that they owe and whether they pay tax on dividends that are reinvested.

To recap, dividends are subject to income tax, capital gains tax (CGT) and dividend tax rules, unless they are held in a tax-efficient account like an Individual Savings Account (ISA) or Self-Invested Personal Pension (SIPP) there’s no income tax, capital gains tax (CGT) or dividend tax to pay.

When receiving cash payments from dividends this will be taxed as income at your marginal taxpayer rate. If you decide to reinvest the cash to buy additional shares, you will not owe taxes until you sell those shares. When receiving income from stock sales, you will be taxed on the income and any capital gains made.

Overall, reinvesting dividends can be a great way to grow your investment over time; however, there are some risks and benefits to consider before making the decision. Ultimately, it is up to the individual investor to weigh these factors and decide what is best for their situation.

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