Dividend Tax Explained for Company Directors
Earn £99,999 and the next pound you take as a dividend costs you 35.75p in tax. Earn a little more, and the very same pound can cost you about 58p. That is more than you would pay on a salary of £200,000.
It sounds like a typing error. It isn't. Between £100,000 and £125,140 of income, the UK tax system quietly removes your tax-free Personal Allowance, and the effect is a hidden tax band that catches thousands of company directors every year. I see it across Tunbridge Wells, Sevenoaks and Tonbridge, usually in the spring, when someone has just had a very good year and wonders why the tax bill looks so heavy.
The good news is that company directors have more control over this trap than almost anyone else. You decide how much to pay yourself, when, and in what form. That flexibility is exactly what you need to avoid it. This guide explains why £100,000 matters, how your personal income is measured, what you can do about it, and how salary, dividends and pension planning fit together. I have used the 2026–27 figures throughout and worked through a full example so you can see the numbers for yourself.
Let's start with the basics, because the trap is easier to avoid once you can see how it is built.
Everyone in the UK has a Personal Allowance, which is the amount of income you can receive each year without paying Income Tax. For 2026–27 it is £12,570. It is the foundation of the whole system, and most people never think about it.
Once your adjusted net income goes above £100,000, the allowance starts to shrink. For every £2 you earn above that figure, you lose £1 of allowance. By the time your income reaches £125,140, the allowance has gone completely.
Here is why that matters. An extra £2 of income above £100,000 doesn't just make that £2 taxable. It also makes £1 of income that used to be tax-free taxable too. So you pay tax on £3 of income for every £2 you earn. Apply a 40% rate to that, and the effective rate on the extra income is 60%.
For directors who take dividends, the position can be worse than 60%. Dividends are taxed in layers on top of your other income, and the loss of the allowance pushes part of your dividends up from the basic rate band to the higher rate band. I modelled this for a director paid a salary of £12,570 with the rest of their income as dividends. Within the trap, each extra £1 of dividend costs about 58.25p in tax. That is the 35.75% higher rate on the dividend itself, plus the extra tax created by the lost allowance.
For other forms of income, such as a bonus, rent or savings interest, the effective rate is about 60%, before any National Insurance.
The thresholds haven't moved with inflation. The government has announced that income tax thresholds will stay frozen until April 2031, which means that each year, more directors drift towards £100,000 without any change in their real standard of living. A director who was comfortably under it five years ago may now be sitting just above it.
The £100,000 line also marks a cliff edge for family benefits. Adjusted net income above £100,000 removes eligibility for Tax-Free Childcare, which is worth up to £2,000 per child each year. In England, it also removes the extended 30 hours of free childcare for three and four-year-olds, leaving the universal 15 hours.
Think about that for a moment. A director with two young children could lose several thousand pounds of childcare support by earning one pound too much. It is not a gradual reduction. It is a cliff.
I once spoke to an IT contractor in Tunbridge Wells whose accountant had never mentioned any of this. He had taken a final dividend of £4,000 in March, just because there was cash in the company. That £4,000 cost him over £2,300 in tax, and more than that in lost childcare. We were able to plan the following year differently, but the damage that year had been done.
To avoid the trap, you need to know exactly what counts. The measure that matters is called adjusted net income, and it is not the same as your salary or your company's profit.
Adjusted net income starts with your total taxable income for the tax year. For a company director, that includes any salary the company pays you, any dividends you receive, and any other income such as rental profits, savings interest, or income from a second job. It also includes taxable benefits, such as a company car, valued at their taxable amount.
Importantly, it is based on the personal tax year, which runs from 6 April to 5 April. It has nothing to do with your company's accounting year. A dividend paid on 3 April counts in one tax year. The same dividend paid on 7 April counts in the next.
Certain items reduce adjusted net income. The two most useful for a company director are personal pension contributions and Gift Aid donations. Contributions to a pension where the provider claims basic rate tax relief are treated as if you had paid the grossed-up amount, and they reduce your adjusted net income by that gross figure. The same applies to Gift Aid donations.
A payment of £19,656 into a personal pension, for example, becomes £24,570 after the provider adds basic rate tax relief. That £24,570 reduces your adjusted net income.
This is the point many directors miss. An employer pension contribution paid by your company is not part of your income at all. It never appears on your tax return. So it doesn't reduce your adjusted net income. What it does is give the company a way to pay you value without paying it as a dividend. By choosing to put £24,570 into your pension instead of paying it as a dividend, you lower the income that is counted. The reduction comes from the dividend you don't take, not from the pension payment itself.
The difference is subtle, but it matters. If you pay yourself the dividend first and then ask the company to make a pension payment, your income is unchanged. The sequence has to be a pension in place of the dividend.
Take a director who receives a salary of £12,570 and dividends of £112,000. Their adjusted net income is £124,570. The Personal Allowance is reduced by half of the excess over £100,000, which is £12,285. That leaves an allowance of just £285.
The director's personal tax bill on this income is £36,089.50. If the dividends were £87,430 instead, adjusted net income would be exactly £100,000. The allowance would be intact, and the tax would be £21,777.48. The difference between the two tax bills is £14,312, on a difference in dividends of £24,570. That is 58.25p in the pound, and it is exactly the trap in action.
Once you can see the trap, the planning options become clear. Some of them cost nothing. Others need a little thought. The right mix depends on your circumstances.
Because you control when dividends are paid, you can often move income between tax years. If you expect to be above £100,000 this year, it may be better to pay part of a dividend after 5 April, so that it falls into the next tax year. If next year's income is likely to be lower, the saving can be substantial.
This works best when it is planned in advance. It also needs the company to have enough distributable profit, which we cover in our guide to Corporation Tax and dividends.
Profit left in the company has already paid Corporation Tax. It doesn't count towards your personal income until you take it. In a year when your income would otherwise hit the trap, it can make sense to leave the excess inside the company and draw it in a later, lower-income year.
There are downsides. The money is exposed to business risk, and it doesn't earn you the Personal Allowance or the basic rate band you could have used. But as a short-term holding position, it is often the simplest tool.
If you have already received the income, a personal pension contribution can still bring your adjusted net income back under £100,000. You pay in the net amount, the pension provider reclaims basic rate relief, and the gross payment reduces your adjusted net income. As a higher rate taxpayer, you can claim the extra relief through Self Assessment.
In our example, a gross contribution of £24,570 costs £19,656 and restores the full allowance. The effective relief on the portion inside the trap can be well above the ordinary 40%, which is why contributions here are so powerful. The drawback is that the money has already been taxed once as a dividend, so the employer route, which I cover below, is usually more efficient where it is available.
If you already give to charity, a Gift Aid donation reduces your adjusted net income by the grossed-up amount. A £8,000 donation becomes £10,000 for this purpose. Nobody should give to charity purely to save tax, but if you are already planning to donate, timing it in a tax year when you are in the trap can add real value.
Directors sometimes ask whether they should give shares to a spouse so that dividends are split. In some cases that can work, but the rules are complicated. The shares must carry real rights, and HMRC has specific anti-avoidance rules about income shifted from one person to another. A spouse's own tax position also matters, because the aim is to reduce the total tax paid, not to move the problem elsewhere. Please speak to us before changing the ownership of your company.
Directors with rental property, large savings or investments sometimes breach £100,000 because of income that is separate from the company. If that is you, the whole picture needs to be looked at, because pension contributions and timing decisions on the company side might need to compensate for income that you cannot easily change.
A company car or other benefit counts towards your income at its taxable value. An electric car with a 4% benefit-in-kind rate adds far less to your income than a high-emission one at 37%. If you are close to the line, even this can matter. Our guide on whether your company should buy a car explains the figures.
Now let's bring it all together. For a company director, three levers control your personal income: salary, dividends and pension contributions.
For most single-director companies, a salary of £12,570 remains a sensible starting point. It uses your Personal Allowance, builds your State Pension record, and costs the company about £1,136 in employer's National Insurance, because the rate is 15% above a £5,000 threshold. A higher salary adds directly to your adjusted net income, and it is deducted before Corporation Tax is calculated. Above the allowance, salary is more expensive overall because of National Insurance, so I rarely recommend it as the main way of reaching or avoiding £100,000.
Dividends are usually the largest part of a director's income, so they are where the trap bites. In 2026–27, dividend tax is 10.75% in the basic rate band, 35.75% in the higher rate band and 39.35% in the additional rate band, with a £500 allowance. Because you decide when and how much to declare, they are also the lever you can adjust most easily. Our guide to salary versus dividends works through the choice in more detail.
The key point for this article is that dividends above the line cost far more than the headline rate suggests. Before you declare a large dividend late in the tax year, check where it will take your adjusted net income.
This is the cleanest solution. The company pays an employer contribution directly into your pension in place of part of the dividend. It is deductible for Corporation Tax, it attracts no National Insurance, and it reduces the dividends you take, which keeps your adjusted net income down. The annual allowance is £60,000, with carry-forward of unused allowance from the previous three years, so for most directors there is plenty of room. Our guide on whether your limited company can pay into your pension covers the mechanics.
Let me put a company and a director through both routes. The company has a taxable profit of £150,000, after the director's salary. The director has a salary of £12,570, is a higher rate taxpayer, and has two children under five.
Route one: take it all as a dividend. Corporation Tax on £150,000 is 25% less marginal relief, which comes to £36,000. That leaves £114,000 after tax. The director takes £112,000 as a dividend, with £2,000 left in the company. Adjusted net income is £124,570, the Personal Allowance is down to £285, and the director's personal tax is £36,089.50. The director keeps £75,910.50. The childcare support is lost, because income is over £100,000.
Route two: employer pension contribution in place of part of the dividend. The company pays £24,570 into the director's pension. Taxable profit falls to £125,430, and Corporation Tax falls to £29,488.95, a saving of £6,511. That leaves £95,941 after tax, from which the director takes £87,430 as a dividend, with £8,511 left in the company. Adjusted net income is now exactly £100,000, so the Personal Allowance is fully restored and the childcare support is kept. The director's personal tax is £21,777.48. The director keeps £65,652.53, plus £24,570 sits in the pension.
What the comparison shows. The total tax paid, company and director combined, falls from £72,089.50 to £51,266, a reduction of about £20,823. The director has £10,258 less cash in hand, but £24,570 more in the pension, and keeps any childcare entitlement. If that childcare is worth, say, £4,000 a year, the benefit is larger still.
I should be honest about the trade-off. The pension money is locked away until age 55, rising to 57 from April 2028, and it is taxed when drawn, apart from the 25% tax-free element. If you need the cash now, this isn't the answer. If you can afford to leave it, the numbers speak clearly. (I have ignored the employer's National Insurance on the salary, which is the same in both routes.)
Then the alternatives are the ones above: shift dividends to a different tax year, leave profit in the company, or make a Gift Aid donation. They help, but they rarely do as much as a pension contribution does for a director who is serious about avoiding the trap.
Quick answer: The £100,000 tax trap is the loss of your Personal Allowance when your adjusted net income goes above £100,000. You lose £1 of allowance for every £2 of income over the line, until it is gone at £125,140. This creates an effective tax rate of about 60% on that slice of income, and for directors taking dividends, about 58.25%. It can also remove Tax-Free Childcare and the extended 30 hours of free childcare.
What this means for a company director: You control your income, so you can usually avoid the trap with planning. The most effective tool is an employer pension contribution paid in place of part of your dividend, which lowers the income that counts without costing you the Corporation Tax deduction. Timing dividends across the 5 April boundary, and leaving profit in the company, can also help.
Example: A director with a salary of £12,570 and a £112,000 dividend pays £36,089.50 in personal tax. Paying £24,570 into a pension in place of part of the dividend brings income down to £100,000 and the personal tax to £21,777.48. With the Corporation Tax saving, total tax falls by about £20,823, and £24,570 goes into the pension.
Common mistakes: Declaring a dividend late in the tax year without checking the effect. Paying the pension after taking the dividend. Forgetting the childcare cliff. Ignoring other income. Looking at the company's profit rather than your own tax year. Waiting until after 5 April.
When should you speak to an accountant? Ideally in the autumn or winter, before the tax year ends, when your income for the year is becoming clear. Speak to us if you are within £30,000 of £100,000, if you have young children, if you have other income, or if you are considering changing who owns the company.
These are the errors I come across most often, and each is easy to prevent.
The employer pension route only works if the pension comes in place of the dividend. Once you have taken the dividend and it is in your account, the income counts. Decide before you pay.
Your company may have a 31 March year-end, but your personal tax year ends on 5 April. Dividends are taxed in the year they are paid. A planning meeting in May is often too late to change what happened the previous April.
The loss of Tax-Free Childcare and the extended free hours can be worth thousands. For a family with young children, that value should be part of every decision. Remember that it depends on adjusted net income, so the same planning that protects your Personal Allowance protects your childcare too.
Rental income, interest and income from a second job all count. A director who plans carefully around company income can still be pushed over the line by something outside the company.
Many people focus on getting just under £100,000. But there is also a point at £125,140, above which the allowance is gone altogether and the additional rate of 45% for income tax and 39.35% for dividends begins. If your income is far above the line, the strategy may be about the overall level, not the trap itself.
The annual allowance is £60,000, and it can be reduced for very high earners. It is also wise to leave enough cash in the company to meet its own tax, wages and VAT. A tax saving is no use if it leaves the company short of money.
The Autumn Budget is due on 28 October 2026. Pensions, dividends and thresholds have all featured in past Budgets. What I have written is correct for October 2026, so check the position again before acting on a large decision.
If your income is close to £100,000, or you suspect you may have crossed it, now is the time to talk. At Peter Hodgson & Co, we work with sole traders, contractors and company directors across Tunbridge Wells, Tonbridge, Sevenoaks and the rest of Kent and the South East. We can map your income for the tax year, show you where you stand against the line, and plan your salary, dividends and pension to keep as much of your money as the rules allow.
To arrange a conversation, you can complete the "Contact Us" form on our website, call us on 01892 515 733, or send us an email at info@peterhodgson.co.uk. A short chat before 5 April could save you thousands!
Disclaimer:
The content of this blog is for general informational purposes only and should not be considered professional tax advice. The information is correct at the time of publishing but may change following future UK budget announcements or updates to HMRC guidance. Individual circumstances vary, and tax obligations can differ based on your personal situation. We strongly recommend consulting with us or a qualified tax professional to receive advice tailored to your specific needs.
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