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 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 tax thresholds frozen bands can hit both personal income tax and business profit margins. Companies may find that profit growth is taxed more steeply, cutting into expansion funds.

As we look ahead to 2025/26, understanding these frozen limits becomes more urgent. If thresholds remain static, that might distort business planning.

This blog explains why these limits can affect your bottom line. It also suggests ways to respond to this risk in the coming year.

What Are Frozen Tax Thresholds?

Frozen limits 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, frozen tax thresholds may push more people into higher tax bands. The idea is quite simple: people pay more tax not because of a rate change, but due to the frozen ceiling.

For business owners, rising profits may end up taxed more heavily. This mechanism can apply to income tax, dividends, or capital gains, depending on policy.

In the UK, frozen bands could apply to multiple 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 retained profit drop as these limits bite. Over time, they 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 remain higher than usual in the UK, even if it moderates. With rising pay, more workers may move into higher tax bands due to frozen limits.

That shift could increase tax revenue because of tax thresholds frozen, lowering take-home pay. Firms may also feel the squeeze because they might pay more in National Insurance or dividend tax.

Under static bands, nominal growth in profit does not always translate into real after-tax gain. For younger firms, it may slow their ability to reinvest, as more profit leaves as tax. In contrast, mature firms may also struggle as they cannot escape the 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 profits stay healthy, tax thresholds frozen may increase your liability.

Impact on Dividend Distributions

Many small and medium UK firms may face higher taxes on dividends because tax bands are frozen. When dividend tax limits stay the same, shareholders may pay more tax, even if payouts do not rise. 

This can lower the value of paying dividends instead of wages or reinvesting. Firms may hold back on dividend growth to avoid extra tax costs for owners or investors.

Capital Gains Tax Exposure

For firms that plan to sell assets or exit, frozen bands may also matter at the capital gains stage. If tax thresholds are frozen for CGT, selling at higher nominal prices may push gains into higher rates.

Therefore, these limits could erode the net capital gain that business founders or investors receive. Over 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 expecting growth may see its tax liability rise due to tax thresholds frozen. 

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 static bands can soak up more profit as tax, cash flow may tighten. Firms may hold back pay or dividends to preserve cash.

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

Impact on Investment Decisions

Firms may delay growth plans when tax thresholds are frozen, raising their effective tax. Projects that appear viable pre-tax may no longer make sense post-tax. Capital-intensive or long-term investments may see reduced returns after higher tax.

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 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. Over time, these limits may discourage risk-taking, particularly in 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

Middle-income earners may face higher rates even without real income growth. Wealthy taxpayers may shelter income, leaving lower- and middle-earners disproportionately affected.

Managing the Risk of Frozen Tax Thresholds

Forecast Profit and Tax Implications

Run forward-looking profit models to simulate different tax scenarios. This helps assess extra tax exposure and supports strategic planning.

Adjust Remuneration Mix

Tilt pay toward non-cash benefits or performance-based structures. Consider delaying dividends if tax drag is too heavy.

Consider Tax‑Efficient Structures

Leadership may restructure ownership to manage liabilities under tax thresholds frozen. 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

Engage trade bodies or policymakers to advocate for inflation-linked thresholds. Collective action may prompt reforms or reviews.

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 review tax thresholds frozen due to complaints. 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?
   They are UK tax bands kept fixed even when wages or profits rise.
2. How do frozen thresholds affect business profits?
   Rising profits may face higher tax, reducing retained earnings for reinvestment.
3. Why are frozen thresholds important in 2025/26?
   Inflation and wage growth could push more income into higher tax bands.
4. Can frozen thresholds increase dividend tax for owners?
   Yes, dividends may be taxed more heavily, reducing shareholder returns.
5. How do frozen bands cause bracket creep?
   Income gradually moves into higher tax brackets without any rate increase.
6. How do frozen thresholds affect retained earnings?
   Higher tax on growing profits reduces the cash available for reinvestment.

7. How do frozen thresholds affect cash flow?
   Higher tax reduces available cash, limiting hiring, expansion, and operational flexibility.
8. Can frozen bands impact investment decisions?
   Yes, higher taxes may reduce the returns on new projects or capital investments.
9. Do frozen thresholds affect capital gains tax?
   Yes, asset sales may fall into higher CGT bands, lowering net proceeds.
10. How can businesses forecast the impact of frozen thresholds?
    By running profit models and simulating different tax scenarios.
11. Can frozen bands affect bonus payments to employees?
    Yes, businesses may limit bonus payments to manage taxable profit levels.

12. Can non-cash benefits help manage tax under frozen thresholds?
    Yes, they can lower taxable profits while keeping employees rewarded.
13. Do frozen thresholds increase National Insurance contributions?
    Yes, static bands may raise employer and employee NI payments.
14. Can frozen thresholds reduce employee take-home pay?
    Yes, wage growth under fixed bands results in higher effective taxes.
15. Are foreign-owned UK businesses affected by frozen bands?
    Yes, any profit generated in the UK may face higher taxation under frozen limits.

16. Can frozen thresholds discourage dividend growth?
    Yes, businesses may delay or reduce dividends to manage tax costs.
17. Do frozen thresholds affect long-term strategic planning?
    Yes, higher tax burdens may influence expansion, hiring, and investment timing.
18. How can businesses minimize the tax impact?
    Forecast profits, optimize pay mix, use allowances, and improve operational efficiency.
19. Should companies engage with policymakers regarding thresholds?
    Yes, advocacy may lead to inflation-linked bands or targeted relief for small firms.
20. Will frozen tax thresholds remain permanent?
    It depends on government policy; thresholds may change in future budgets.