Thursday, January 5, 2023
Maximise your income by cutting tax liability
Taxes are a fact of life and there’s no escaping them. But, you can take action to minimise your liability and maximise your earnings.
As we start a new year, now is a good time to take a close look at what cash is coming in and look at ways to prevent it going straight back out.
Very often, opportunities to increase your after-tax earnings are lost, and permanently lost, because key actions were not taken before the end of the tax year, or the end of your business trading year.
Tax planning for individuals
- To lower the impact of a higher rate tax (or marginal rates), consider sharing ownership of income-producing assets with your spouse, especially if your spouse pays no income tax, or tax at lower rates.
- Similarly, consider sharing ownership of income-producing assets with your adult children (over 18 years). Your children, whatever age, can earn up to £12,570 this tax year without paying income tax. Transfers of certain assets may create a Capital Gains Tax liability, and so planning is key.
- If you have a pension scheme, take advice from your pension’s advisor on the level of contribution you should make this year. The maximum you can pay in is £40,000 unless you pay tax at 45 per cent, in which case the annual limit could be as low as £10,000.
- There are no limits to the amount in gift aid donations you can make. These contributions extend your basic rate tax band and are an effective strategy for avoiding the higher and marginal rates of income tax. Charitable donations are also one of the few remaining reliefs that you can carry back, in certain circumstances, to the previous tax year.
- You can transfer up to £1,260 of your personal allowance to your spouse if you don’t earn enough to fully utilise this allowance against your own earnings. You can only do this if their income is between £12,571 and £50,000.
- If you are provided with a company car and your employer pays for your private fuel, you should consider repaying this private fuel cost to your employer in order to avoid the punitive car fuel benefit charge. This will also save your employer National Insurance charges.
- A further consideration for company car drivers is to discuss changing your vehicle for a lower CO2 emissions model. The car benefits charge increases in direct proportion to these CO2
- Don’t forget to use your ISA allowance. In this way you can invest up to £20,000 in the current tax year and any interest earned will be tax free.
- There are a number of specialist investments you can make that are qualifying deductions for income tax purposes. They include: the Enterprise Investment Scheme, investments in certain Social Enterprises, Seed Enterprise Investment Schemes and Venture Capital Trusts. Income tax relief varies between 30 per cent and 50 per cent of the qualifying investments. You will need to consider the commercial risks as well as the tax advantages.
- Don’t forget that the State Pension is treated as taxable income for tax purposes. You are paid without deduction of tax. If your total income (including your State Pension) exceeds £12,570, this may produce unwelcome bills from the tax office at the end of the tax year.
- Although not strictly a tax planning matter, if you have an outstanding mortgage on your home, the current upward pressure on interest rates will be causing concern. The funds you use to repay your mortgage come from your after-tax income. Discuss ways to pay-off part of the loan with your mortgage adviser and if you can convert an interest only mortgage to a repayment variety this will drastically reduce the interest cost of your loan.
Self-employed tax review
- The income tax you will pay for 2022-23 will based on your profit or share of profits for the trading year ending in the 2022-23 tax year. However, you will have made two payments on account for 2022-23 (January and July 2023) based on your profits for the preceding year. Accordingly, if your profits are increasing you will likely have underpaid tax for 2022-23 and any balance owing will be payable 31 January 2024. If your profits are decreasing, you can elect to make a smaller payment on account. Either way, having your estimated trading figures available, to forecast your 2023 tax payments, means you have ample time to request reductions in payments on account or save to meet any balance due January 2024.
- Every self-employed person is entitled to earn £12,570 during 2022-23 without paying income tax. If your projected profits (or share of profits), assessable in 2022-23, are lower than this amount, your personal tax allowance (or part of the allowance) may be wasted. To avoid this, you can defer claims for capital allowances, or perhaps defer refurbishment or other non-recurring costs to increase your taxable profits, and fully utilise your personal tax allowance. These adjustments will tend to push tax relief on deferred expenditure into future years.
- If your share of profits looks as if it will breach one of the thresholds and push you into higher, marginal rates of tax (for example: loss of child benefit if income exceeds £50,000, loss of your personal allowance if your income exceeds £100,000, or a 75 per cent reduction in the amount of pension relief you can claim if your income exceeds £150,000). To counter these risks, you could consider bringing forward capital investments, in plant, equipment or commercial vehicles and claim additional capital allowances.
- Self-employed farmers, who can experience significant variations in the level of profits achieved, should take advantage of the extended averaging rules that entitle them to average their profits over a five-year or two-year period for 2022-23.
- In planning for tax payments, based on profits assessable for 2022-23, business owners should be aware that generous tax allowances are still available for qualifying capital expenditure. The Annual Investment Allowance allows you to claim a 100 per cent write-off for expenditure up to a £1m limit. This is a useful adjustment device to reduce taxable profits and save tax, while maintaining published profits in your profit statement.
- Class 4 National Insurance is based on the level of business profits: 10.25 per cent on profits between £11,909 and £50,270, and 3.25 per cent on profits over £50,270. Any reductions you can achieve in your taxable business income will also reduce this significant NIC charge.
- Since 2016 the rules for the VAT Flat Rate Scheme have changed. All users of this scheme should crunch the numbers to see if they qualify as a limited cost trader. If they do, a flat rate of 16.5 per cent must be applied and this may preclude the advantages of registering for the scheme.
Limited company tax review
- Incorporated businesses are taxed at corporation tax rates, currently 19 per cent, and any profits retained in the business will be subject to no additional tax charge. This final point illustrates one of the major advantages of running a profitable business inside a limited company structure. If you are self-employed you may want to consider the benefits of incorporating your business.
- From April 2023, two rates of corporation tax will apply. Smaller companies with profits up to £50,000 will continue to pay corporation tax at 19 per cent. Companies with profits in excess of £50,000 will be subject to a 25 per cent rate. Firms with profits between £50,000 and £250,000 will be able to claim marginal relief.
- The marginal rates reduction from April 2023 will be reduced if companies have associated businesses. Prior to April 2023 it is recommended that companies consider restructuring these associated businesses to avoid unnecessary increases in their corporation tax payments.
- Shareholders should review any plans in place to deal with succession, especially, smaller family businesses. This review should consider personal circumstances, changes in the company’s financial status, and changes in tax legislation.
- Shareholders should also review shareholder agreements to ensure they still reflect the intentions of signatories.
- Presently, shareholders’ dividends up to £2,000 can be drawn tax free. Would it be possible to issue shares to adult children and provide them with a tax-free income?
- If all the shareholders of a small company hold the same class of shares, say ordinary shares, dividends will be paid based on the percentage held. This can be inconvenient if directors want to split dividends in a different proportion to equalise tax liabilities. One way to achieve this result is to convert existing shares into a number of different classes, say “A”, “B” shares et., and in this way shareholders can receive dividends in a more tax efficient manner.
- Review the active participation of director/shareholder family members. Is there an opportunity to employ a spouse or child; or provide taxable benefits?
- Directors who have overdrawn their loan accounts with the company should consider taking a dividend to clear the loan (if reserves are available) or otherwise repaying the loan within nine months of the trading year-end. In this way an additional (albeit temporary) 33.75 per cent corporation tax charge can be avoided.
- Directors with semi-permanent deposits on loan to the company, may be advised to charge the company interest. Basic rate income taxpayers can receive up to £1,000 in interest tax free, higher rate taxpayers £500.
- The tax on costs of running a company car fleet – class 1A National Insurance for instance – as well as the considerable tax implications for participating employees, may provide sufficient justification for a change in strategy. For example, could the company lend employees funds to buy their own cars and pay them a tax-free business mileage allowance to cover running costs?
- If projected profits forecast a temporary dip, or a loss in the short-term, could the company’s accounting period be extended to embrace the loss and average down the taxable profits for the preceding period?
- If projected profits are forecasting a downturn in profits, how will this affect director/shareholders’ remuneration in the coming months; will there be sufficient retained profits to maintain regular dividend payments?
- Be sure to consider the funding of corporation tax payments that will need to be made nine months and one day after the company’s accounting year-end date.
- Companies can still claim the 130 per cent super-deduction for purchases of qualifying assets purchased before 31 March 2023. For example, an asset costing £10,000 will create a tax deduction of £13,000. At 19 per cent tax relief, this is a tax saving of £2,470, reducing the after-tax cost to £7,530.
If you would like to discuss any of the points included in this article, please get it touch.