By Phil Ellerby
One of the major personal goals for business owners is improving our income. Let’s face it, we’d all like to take home a little bit more cash at the end of each month.
Your annual aim might be to earn £20k, £50k, £100k or more. Whatever that goal may be, it’s completely up to you - but knowing how to pay less tax could be the key to helping you achieve it.
Although the tax rates which apply to companies and personal income are readily available online, it’s a good idea to know the basics:
Now that we know the tax rates which apply to our personal income, we can start to look at ways that will help us to pay less tax – all of which are perfectly legal.
One of the easiest ways to pay less tax is to reduce your taxable income.
Fortunately, you don't have to turn down a pay rise to do this. Instead, utilising legitimate tax deductions will allow you to reduce the amount of tax you pay.
If you are close to becoming a higher rate tax payer this could stop you from losing your personal allowance or (if you have kids under the age of 18) help you to keep receiving Child Benefit payments.
Okay, so this is a basic one – but you’d be surprised to find out how many people are on the wrong tax code each year. If you are, you could be paying too much tax.
Anyone who is self-employed is entitled to deduct legitimate business expenses before paying their tax bill - so it is well worth taking full advantage of this.
If you run a business from home, this can include bills for lighting, heating, telephone, broadband, council tax, property insurance and mortgage interest – but only if the costs involved are judged to be “fair and reasonable” by HMRC. Stationery and computer equipment are also on the list of things which are tax deductible.
By offsetting these costs against profits, you can reduce your overall tax bill and pay less tax.
Although the cost of buying a car cannot be classed as a deductible expense if you are self-employed, you are entitled to claim for the costs of running one. If the same vehicle is used privately, you can only claim a proportion of the total costs incurred – usually by claiming a mileage allowance.
Paying into a pension can be extremely tax efficient, but a lot of business owners fail to make the most of pension savings. In the 2016-17 tax year, a UK taxpayer will get annual tax relief on pension contributions of up to £40,000 or 100% of their earnings (whichever is the lowest).
Since 6 April 2016, the first £5,000 received in dividends from investments has been tax-free – which has made this a popular option when it comes to paying yourself in the most tax efficient way.
Basic-rate taxpayers will pay 7.5% tax on dividends they receive above the threshold, with higher-rate taxpayers paying 32.5% and additional-rate taxpayers charged 38.1%.
Be warned though, from April 2018 the dividend allowance will be reduced from £5,000 to £2,000. This will have an impact on the amount of tax you pay – and the amount you take home.
Giving gifts to charity doesn’t just make you feel good inside, it will also help you to pay less tax – but only if you add Gift Aid to the donation. To reduce your taxable income, it is also important to keep a record of all charitable donations as this will make it easier when the time comes to file your tax return.
Sacrificing your salary in exchange for a non-cash benefit is a perfectly legal way to reduce pre-tax income.
Basically, it is a contractual agreement between an employer and employee which sees the staff member give up part of their pre-tax earnings to pay for things like child care vouchers, medical insurance, gym membership or car leasing. Cycle to work schemes which allow employees to buy a bike are also popular.
If you’d like to set up a salary sacrifice scheme, the first point of call is your payroll department or accountant, who will be happy to discuss the potential opportunities.
Every business owner has a personal allowance on which they do not pay any tax. As shown in the table above, that allowance is currently £11,000.
If your spouse or partner does not work, employing them could help you to pay less tax by spreading the income of your business between two parties.
Even if you are a higher rate tax payer, this tactic can help you pay less tax.
Instead of paying yourself £100,000 and paying tax at an annual rate of 40% on everything above £42,475 (which incurs a tax bill of £23,010), you could employ your partner and both receive a salary of £50,000.
This simple step would see you pay 40% tax against just £15,050 of earnings (instead of the whopping £57,525 in the above example), which would mean an overall tax bill of £6,020.
Now that we know the tax rates which apply to our personal income and we’ve picked up a few tips how to pay less tax, it’s worth asking:
What is my combined tax rate?
Do you know the answer? If you do, you’re one of the privileged few – because the calculation actually takes into account many different variables.
However, if you are armed with this information you can start to take steps which would reduce this tax rate and increase your take-home pay.
By decreasing the amount of tax payable, it effectively increases your wage without having to take any additional money out of the business – helping to improve cash flow and alleviating financial pressures.
A no brainer!
At Northern Accountants, we now have a piece of software which can calculate this rate for you – before providing suggestions on what you can do to reduce this tax rate.
If you’d like us to run this software on your behalf (at our expense), please get in touch or call 0113 218 9552 - and put the decision about how much tax you pay back in your hands.