How Frozen Tax Thresholds Will Hit Your Profits in 2025/26

In the UK, Frozen Tax Thresholds may sharply erode firm profits when inflation stays high. This concept of Frozen Tax Thresholds refers to a stoppage in raising tax bands while wages rise. 

When tax limits do not change, many more people may be dragged into higher tax rates. Those Frozen Tax Thresholds can hit both personal income tax and business profit margins. 

Companies may find that profit growth is taxed more steeply under Frozen Tax Thresholds, cutting into expansion funds. As we look ahead to 2025/26, understanding Frozen Tax Thresholds becomes more urgent. 

If those thresholds remain static, that might distort business planning. This blog explains why Frozen Tax Thresholds can affect your bottom line. It also suggests ways to respond to Frozen Tax Thresholds risk in the coming year.

What Are Frozen Tax Thresholds?

Frozen Tax Thresholds occur when the government locks tax bands for income or gains. Rather than adjusting thresholds for inflation, they keep the same numeric limits. 

Over time, pay or profit growth will push more people into higher tax bands under Frozen Tax Thresholds. The idea is quite simple: people pay more tax not because of a rate change, but due to the frozen ceiling. 

For business owners, Frozen Tax Thresholds may mean that profits that rise end up taxed more heavily. This mechanism can apply to income tax, dividends, or capital gains, depending on policy. 

In the UK, Frozen Tax Thresholds could apply to multiple tax tiers, including basic rate, higher rate, and additional rate bands. When thresholds stay still while pay and profit grow, taxpayers may face a stealth tax hike. 

Small firms may notice their retained profit drop as Frozen Tax Thresholds bite. Over time, Frozen Tax Thresholds may significantly reduce after‑tax returns for many.

Why Frozen Tax Thresholds Matter in 2025/26

Rising Inflation and Wage Growth

In 2025/26, inflation may well remain higher than usual in the UK, even if it moderates somewhat. With rising pay, more workers may move into higher tax bands due to Frozen Tax Thresholds. 

That shift could generate a higher tax take for HMRC, but a lower take‑home pay for employees. Firms may also feel the squeeze, because they might pay more in National Insurance or dividend tax. 

Under Frozen Tax Thresholds, nominal growth in profit does not always translate into real after‑tax gain. As costs climb, the impact of Frozen Tax Thresholds on business margins can become acute.

For younger firms, Frozen Tax Thresholds may slow down their ability to reinvest, as more profit leaves as tax. In contrast, firms with stable or mature profits may also struggle, as they cannot escape a new burden.

Bracket Creep

One key risk lies in “bracket creep.” This is when taxpayers slowly drift into higher tax bands without any formal rate rise. 

Frozen Tax Thresholds accelerate bracket creep by not adjusting thresholds to reflect real wage or profit growth. 

This means that even if your profit level stays healthy, your tax burden might grow.

Impact on Dividend Distributions

As many small or medium-sized UK firms rely on dividend distribution instead of large salaries, Frozen Tax Thresholds hit this channel hard. 

When dividend tax thresholds remain frozen, shareholders may pay more tax, even if they did not increase distributions. 

That, in turn, can reduce the net benefit of paying dividends rather than wages or reinvesting. So Frozen Tax Thresholds may encourage firms to rethink dividend policy or restructure pay. 

Businesses might even pause dividend growth to avoid adding tax costs for owners or investors.

Capital Gains Tax Exposure

For firms that plan to sell assets or exit, Frozen Tax Thresholds may also matter at the capital gains stage. 

If CGT bands remain fixed, selling at a higher nominal price may push gains into higher CGT rates. 

Therefore, Frozen Tax Thresholds could erode the net capital gain that business founders or investors receive on sale. Over a long time, this effect can discourage exits or drive decisions to defer sales.

How Frozen Tax Thresholds Hit Business Profits

Reduced After‑Tax Profits

When you calculate profit projections, Frozen Tax Thresholds may reduce what you keep. A firm that expects to grow may find its tax liability rising faster than its growth. 

That reduces net profit, making reinvestment harder. As profit grows, more of it may fall into higher tax brackets. This means your margin per pound may shrink.

Cash Flow Pressure

Because Frozen Tax Thresholds can soak up more profit as tax, cash flow may tighten. Firms may hold back pay or dividends to preserve cash. That can reduce liquidity, which is critical for operations or for growth. 

With less retained cash, firms could struggle to fund capex or pay down debts. They may also postpone hiring or expansion in response.

Impact on Investment Decisions

Firms may delay or scale down growth plans due to Frozen Tax Thresholds risk. If potential tax drag is heavy, the return on the new investment may fall. 

As a result, growth projects that appear viable on a pre‑tax basis may no longer make sense. This may particularly hit capital‑intensive or long‑term investments whose returns drop after higher tax. Thus, Frozen Tax Thresholds may distort corporate capital allocation.

Strategic Salary vs Dividend Mix

To cope with Frozen Tax Thresholds, business leaders may re‑balance pay between salary and dividends. They may cut salaries and raise dividends to manage tax bills. But dividend payouts under a fixed threshold may also become more costly.

 Alternatively, firms may offer non‑cash benefits to reduce taxable profit. Yet, these strategies may increase administrative complexity. Not all firms will feel that trade‑off is worth the cost.

Impact on Small Firms and Startups

Startups may be especially hit by Frozen Tax Thresholds, since they often depend on reinvested profit. New firms may delay growth or reduce hiring if tax burdens rise. 

Smaller firms may have less flexibility to absorb additional tax fees. This risk may especially hurt owner-run businesses with thin margins. 

Over time, Frozen Tax Thresholds may discourage risk-taking, particularly early‑stage firms.

Wider Economic Effects of Frozen Tax Thresholds

Reduced Consumer Spending

If workers pay more tax due to Frozen Tax Thresholds, their disposable income might shrink. That may lower overall consumer demand. 

Firms that depend on consumer spending may suffer because of that drop. In turn, firms might defer investment or cut costs. Slower spending growth could feed into slower economic growth overall.

Labour Market Distortion

As Frozen Tax Thresholds push more people into higher tax bands, workers may reconsider working more hours. Some may reduce overtime, seeking to avoid an extra tax burden.

That might reduce productivity or labour supply. Others may demand pay rises to offset higher effective tax rates. Those demands may feed into further inflation, creating a negative cycle.

Increased Government Revenue

From the public finance view, Frozen Tax Thresholds may raise revenue for the government without raising tax rates. That might help the treasury meet fiscal targets or fund public spending. 

However, that revenue boost is partly stealth taxation, since nominal thresholds do not transparently change. Critics may argue this is a hidden tax hike, shifting the burden quietly.

Inequality Concerns

Because Frozen Tax Thresholds can disproportionally hit middle earners, inequality may worsen. Middle-income earners may face higher rates even without real income growth. 

Higher earners may find more ways to shelter income, reducing the burden more. Thus, Frozen Tax Thresholds may shift the burden to those less able to plan around tax changes.

Managing the Risk of Frozen Tax Thresholds

Forecast Profit and Tax Implications

To handle Frozen Tax Thresholds, managers should run forward‑looking profit models. They may simulate different tax burden scenarios under frozen bands. 

That helps assess how much extra tax may hit future profit. It also supports decisions on pay, reinvestment, or dividends. Scenario planning may guide strategy under Frozen Tax Thresholds risk.

Adjust Remuneration Mix

Firms may revise how they pay owners and staff. They may tilt pay more toward non‑cash benefits, reducing taxable profit. Or they may choose lower salaries with more performance‑based pay. 

Some owners may raise dividends only where tax efficiency remains good, even under Frozen Tax Thresholds. Others might delay distributions if the tax drag is too heavy.

Consider Tax‑Efficient Structures

Leadership may seek advice to restructure ownership or operations for better tax impact. For example, they might use trusts or holding companies to optimise for dividend or capital gains tax. 

They may use reliefs or allowances to reduce the liability burden. Using advisors who track tax policy shifts is crucial under Frozen Tax Thresholds risk. Good planning can ease the impact.

Delay Realisations or Sales

Firms or founders may delay asset sales if they fear a heavy capital gains tax. Under Frozen Tax Thresholds, a sale might push gains into a higher band. 

Delaying may let the seller use allowances or timing to reduce tax. That can preserve more of the exit proceeds. This requires balancing market risk against tax savings.

Lobby and Policy Engagement

Businesses may engage with trade bodies or policymakers to argue for or against Frozen Tax Thresholds. 

They might press for indexed thresholds or inflation-linked tax bands. Industry groups may push the government for reforms to avoid stealth taxation. 

Firms may share data to illustrate how Frozen Tax Thresholds undermine growth. Collective action might prompt review or change.

Increase Efficiency and Reduce Costs

If cash flow is squeezed by Frozen Tax Thresholds, firms may work to cut costs. They may look to streamline operations, reduce waste, or renegotiate supplier contracts.

Improving efficiency can offset some of the extra tax burden. Leaner operations may preserve margin and liquidity even under higher tax loads. That gives firms more resilience.

Potential Counter‑Arguments and Risks

Some may argue that Frozen Tax Thresholds only hit certain groups, not all. It may be said that the wealthy can shield their income more easily. 

Others may oppose indexation, but that could reduce progressive policy aims. There is a risk that freeing thresholds would reduce government income sharply. 

Some firms may overstate the hit from Frozen Tax Thresholds in order to push for subsidies or tax breaks. There is also uncertainty: thresholds may freeze now but may change later, so firms may mis‑forecast.

Policy Outlook: What Might Happen Post‑2025/26

It is possible that in future budgets, the government may respond to complaints about Frozen Tax Thresholds. They might reintroduce index links to protect taxpayers from bracket creep. Alternatively, they might hold thresholds steady further, to protect revenue.

 They may also consider targeted reliefs for small firms if Frozen Tax Thresholds stall growth. Some reform could come via sunset clauses or planned reviews. Monitoring government policy is essential for firms feeling risk from Frozen Tax Thresholds.

Case Study: A Small UK Firm Facing Frozen Tax Thresholds

Imagine a small consultancy firm in London. It made a decent profit in 2024 and expects growth in 2025/26. But due to Frozen Tax Thresholds, that growth might push the director into a higher tax band. They may pay more dividend tax, hurting personal net income. Meanwhile, the firm may cut back on hiring because the added tax burden reduces reinvestment capacity. To cope, the director may take advantage of tax‑efficient pay structures. They may also run profit models to forecast the toll of Frozen Tax Thresholds. This case illustrates how even a modest business may suffer under frozen tax bands.

Frozen Tax Thresholds pose a significant risk to UK business profits in 2025/26. By not adjusting tax bands for inflation or wage growth, more profit may be taxed at higher rates. This can erode after‑tax returns, tighten cash flow, and force difficult decisions on pay and investment. 

Small firms and startups may feel the pain most, since they rely on retained earnings for growth. Yet, with good planning, these risks can be managed. Forecasting, pay‑mix adjustments, structural tax advice, and efficient cost management all help. Engaging with policymakers also matters for long-run reform. While Frozen Tax Thresholds may not be avoidable completely, proactive firms can soften their blow.

At Meru Accounting, we provide accounting and bookkeeping for small businesses under tax pressure. We have certified experts who can check your finances, track profit changes, and keep records correct under new tax rules. 

Our team can make clear accounts, watch cash flow, and spot where tax may rise from frozen thresholds. With precise records and skilled support, firms can keep strong financial health despite tax shifts. Partner with us to manage your finances well and make smart business choices.

FAQs

1. What are Frozen Tax Thresholds in the UK?
   They are tax bands left unchanged despite wage or profit growth.
2. How do Frozen Tax Thresholds affect UK business profits?
   Firms may pay higher tax on growing profits unexpectedly.
3. Why will Frozen Tax Thresholds matter in 2025/26?
   Rising wages and profits push more income into higher rates.
4. Can Frozen Tax Thresholds reduce after‑tax business earnings?
   Yes, higher tax bills lower net profit and cash available.
5. Do Frozen Tax Thresholds impact dividend payments for owners?
   They can increase tax on dividends, reducing shareholder returns.
6. How do Frozen Tax Thresholds cause bracket creep?
   Earnings rise into higher bands without any rate increase.
7. Are small UK firms more affected by Frozen Tax Thresholds?
   Yes, smaller firms rely on retained profits for reinvestment.
8. Can Frozen Tax Thresholds affect business investment decisions?
   Yes, a higher effective tax may reduce funds for expansion.
9. Do Frozen Tax Thresholds apply to National Insurance contributions?
   They can increase employer and employee payments on earnings.
10. Can Frozen Tax Thresholds impact exit or sale planning?
    Yes, they may raise capital gains tax on asset sales.
11. How can firms plan around Frozen Tax Thresholds?
    Forecast profit, adjust pay mix, and review tax structures.
12. Are Frozen Tax Thresholds temporary or long‑term?
    They depend on government policy and future budget decisions.
13. Do Frozen Tax Thresholds affect employee take‑home pay?
    Yes, wages rising under static thresholds face higher taxes.
14. Can Frozen Tax Thresholds reduce cash available for hiring?
    Higher tax on profits may tighten firm liquidity significantly.
15. Should firms consider delaying dividends due to Frozen Tax Thresholds?
    Yes, delaying may reduce the immediate tax impact on owners.
16. Do Frozen Tax Thresholds impact inflation‑adjusted earnings?
    Yes, profits rise in nominal terms but are taxed at a higher rate.
17. Are startups more vulnerable to Frozen Tax Thresholds?
    Yes, they rely heavily on profit retention for growth funding.
18. Can tax planning reduce the effect of Frozen Tax Thresholds?
    Yes, effective pay structuring and allowances may mitigate tax.
19. Do Frozen Tax Thresholds increase overall government revenue?
    Likely, as more income enters higher tax bands automatically.
20. Should businesses monitor government budgets for Frozen Tax Threshold updates?
    Yes, policy changes may alter thresholds or introduce reliefs.