How to pay less tax AND reduce your overall tax rate (legally!)
Are you having trouble sleeping at night because you are thinking about how to pay less tax?
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.
Depending on your level of income, these tips 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.
8 easy steps to help you pay less tax
1. Check your tax code
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.
2. Know all your job-related allowances
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.
3. Claim self-employed car costs
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.
4. Pay into your pension pot
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 2023/24 tax year, a UK taxpayer will get annual tax relief on pension contributions of up to £60,000 or 100% of their earnings (whichever is the lowest). We can help you to calculate your available annual allowance.
5. Use your dividend allowance
The dividend allowance was introduced on 6 April 2016, whereby the first £5,000 received in dividends from investments was tax-free. However, since then the dividend allowance has been reduced again and again over the years. For the 2023/34 tax year, each individual is entitled to a tax-free dividend allowance of £1,000 so it is still worthwhile to consider dividends when rewarding yourself.
Basic-rate taxpayers will pay 8.75% tax on dividends they receive above the threshold, with higher-rate taxpayers paying 33.75% and additional-rate taxpayers charged 39.35%.
6. Give gifts to charity
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.
7. Salary sacrifice
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, that 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.
8. Employ your partner
Every business owner has a personal allowance on which they do not pay any tax. For the 2023/24 tax year, that allowance is £12,570.
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 in the household.
Even if you are a higher-rate taxpayer, 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 £50,270 (which incurs an overall tax bill of £27,432), you could employ your partner and both receive a salary of £50,000.
This simple step would see you pay just 20% tax against your earnings (instead of paying 40% tax against the whopping £49,730 in the above example), which would mean a tax bill of £7,486 for each partner, resulting in an overall tax bill of £14,972 for the couple. This could result in an incredible tax saving of £12,460!
Discover how to reduce your overall tax rate
Now that we know the tax rates which apply to our personal income and we’ve picked up a few tips on 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 that would reduce this tax rate and increase your take-home pay.
By decreasing the amount of tax payable 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 that 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 – and…