Between 2022 and 2024, the UK government cut the dividend allowance from £2,000 to £500. That's a 75% reduction in two years, with almost no fanfare compared to other tax changes of similar size. No political protests. No contractor associations kicking up the fuss they make about IR35. Just a quiet, effective, annual reduction that has collectively cost limited company contractors hundreds of millions of pounds in additional tax.
The way it is usually reported — "allowance cut to £500" — does not communicate the real money. Here is what it actually costs a typical contractor, at three income levels, in pounds you can feel.
What the dividend allowance actually does
The dividend allowance is the amount of dividend income you can receive each year without paying dividend tax on it. Above that, dividend tax is 8.75% at the basic rate, 33.75% at the higher rate, and 39.35% at the additional rate. The allowance is not a cap on how much you can take as dividends. It is a reduction in how much of those dividends is taxable.
When the allowance was £2,000, the first £2,000 of dividends was free of dividend tax. Now it is £500. The difference — £1,500 — is now taxable. What that £1,500 costs you depends entirely on which band it falls into, which is why a junior contractor and a £500/day contractor do not feel this cut the same way.
The actual cost in numbers — three contractor scenarios
These are simplified illustrations: £5,000 salary, remaining profit taken as dividends, 19% corporation tax on profits after salary, no other income. Real returns have more moving parts. The point is the delta, not a substitute for a full computation.
Scenario 1 — Junior contractor, £40,000 annual profit
Salary of £5,000 leaves £35,000 in the company. Corporation tax at 19% is £6,650, which leaves about £28,350 to take as dividends. Under the old £2,000 allowance, dividend tax applied to £26,350. At the basic rate of 8.75% that is £2,306. Under the current £500 allowance, dividend tax applies to £27,850, which is £2,437. The cuts cost this contractor £131 a year.
Annoying. Not a reason to dissolve the company on its own. At this profit level the Ltd versus sole trader question is already close once you count the accountant, and £131 does not help the Ltd case.
Scenario 2 — Mid-level contractor, £70,000 annual profit
At this level, dividends start pushing into the higher rate band. That is where the allowance cut stops being a rounding error. The old £2,000 allowance saved £2,000 × 8.75% = £175 if those dividends sat in the basic rate. The current £500 allowance saves £500 × 8.75% = £43.75. Once you are a higher-rate taxpayer, the £1,500 that used to be covered by the allowance is taxed at 33.75%, not 8.75%. That is £1,500 × 33.75% = £506 a year.
The rate is the whole story. The same £1,500 of lost allowance costs a basic-rate contractor about £131 and a higher-rate contractor £506. The cut was designed to look small in a Budget table. For anyone whose dividends have already filled the basic rate band, it is four times more expensive than the 8.75% headline implies.
Scenario 3 — Senior contractor, £115,000 profit (£500/day)
At this level most of the dividend income is already in the higher rate band. The same £1,500 lost from the allowance cut costs £1,500 × 33.75% = £506 a year — the same as the mid-level contractor, because it is the same £1,500 taxed at the same rate. Going from £70,000 to £115,000 does not make this particular cut worse. Other things do: frozen income tax thresholds pulling more of the remaining dividends into higher rate, and the employer NI changes sitting underneath the salary.
That doesn't sound catastrophic — but there's more
£506 a year is not a crisis. The problem is that it did not arrive alone. The dividend allowance cut landed in the same window as the employer National Insurance secondary threshold dropping from £9,100 to £5,000 in April 2025, with the rate rising to 15%, and a multi-year freeze on income tax thresholds that quietly pushes more dividend income into the higher rate band every April.
Taken together, limited company tax efficiency has genuinely eroded since 2022. Not catastrophically. Meaningfully. Anyone still quoting take-home numbers from a 2021 spreadsheet is describing a tax system that no longer exists.
Does this change whether a limited company is worth it?
The honest answer is that the crossover point has moved up. The old £30,000 rule of thumb is no longer accurate. In 2026/27, with a realistic accountant cost baked in, the typical crossover sits around £50,000–£60,000 of profit. Below that range, the annual tax saving is often smaller than the accountant fees and the admin burden. Above it, the company still wins — by less than it used to.
For contractors the calculation has to run alongside IR35 status. Outside IR35, a Ltd above the crossover is still the better structure for most people. Inside IR35, the dividend model is largely gutted and the allowance cut is almost beside the point — you are already paying employment-style tax plus company admin. Run both questions, not one.
Find where the crossover sits for your specific income and expenses.
Open Ltd vs sole trader calculator →What to do if you haven't reviewed your salary/dividend split recently
The £5,000 salary strategy is still correct for most single-director companies — sitting at the employer NI secondary threshold, with no employer NI, no employee NI, and a qualifying year for State Pension. What may have changed is whether the overall Ltd structure still produces meaningfully better take-home than operating as a sole trader at your current income. That is a different question from whether the salary number is right.
Run the numbers. Ideally with an accountant who has seen the 2025 and 2026 changes, or as a sanity check with a calculator before you book that conversation. Assuming the economics are the same as when you first incorporated is how people spend two years paying for a structure that no longer earns its keep.
Calculate your optimal salary and dividend split for 2026/27.
Open dividend calculator →The broader pattern worth noticing
There has been a quiet erosion of contractor tax advantages since around 2016. IR35 reform, allowance cuts, employer NI threshold changes, frozen income tax bands. None of them was individually dramatic enough to dominate a news cycle the way a rate rise would. Collectively, over ten years, the landscape is significantly less favourable than the one the previous generation of IT contractors incorporated into in the 2000s and early 2010s.
The numbers still work for a lot of contractors. They just need running for 2026, not 2016. That is the entire point of putting pounds on a cut that most coverage treated as a footnote.