Whatever your current circumstances, whether liquidity is ample, or you have more modest resources to call upon, it is always important to prepare well for future tax bills.
You may be a bookkeeping wizard. But a few reminders as to how you can best provide for your tax bills, can go a long way towards never having unwanted surprises again.
Rates are as at the 20-21 tax year. Rishi may decide to tinker with these in 21-22 depending on how he decides to pay for the Pandemic. I will write to you separately on this after the 3rd March budget.
Income tax
When you’re in employment, you are placed on the Organisation’s Payroll. Consequently your income tax and NI are collected at source via the ‘Pay As You Earn’ (PAYE) scheme and paid directly to HMRC. Job done!
However, income tax and NI on most other areas of income are not collected at source. The income (over the period 6th Apr to 5th Apr) is reported via ‘self-assessment’, the tax on which is then paid to HMRC by the taxpayer themself.
Most taxpayers are granted a personal allowance of £12,500 whereby taxable income up to that threshold is tax free. The next £37,500 is then taxed at 20% (basic rate), the next £100,000 is taxed at 40% (higher rate), and anything else at 45% (additional rate).
A good routine to get into is to periodically project what you would expect to earn in total in the year. Divide the income into the tax thresholds as above, and apply the tax rates accordingly. Deduct any tax that you’ve already paid (e.g. via PAYE) and there you have it. Make contributions towards your end-of-year bill by putting money aside into a separate savings account.
National Insurance
NI represents our contributions towards certain benefits and the state pension. Like income tax though, we should make provisions towards NI bills that have not otherwise been collected via PAYE.
If you’re employed, you pay class 1 NI. The first £9,516 is tax free, the next £40,508 is taxed at 12% with anything else taxed at 2%. Normally, these are collected by your employer.
If you’re self-employed you pay class 2 & class 4 NI, and it’s up to you to plan for and pay your bill. Class 2 is a flat £158.60 if you earn over £6,475. For Class 4, the first £9,500 is tax free, the next £40,500 is taxed at 9% and anything else is taxed at 2%
Again, tot up what you expect to earn, apply the thresholds and rates, deduct what you’ve paid at source, and put aside your best estimate for what the bill will be.
Student loans
Getting up in the afternoon, drinking drip-trays and wearing traffic cones is but a distant memory.
Now is time to pay for the privilege. If you have student debt, you will asked to repay 9% per year on any income over £19,380 until the balance has been repaid.
Time to put that separate savings account to good use.
Tax on Dividends
Whilst dividend income is subject to the same thresholds as income tax, an additional £2k of your income is tax free (the dividend allowance).
Furthermore, rates of tax are more favourable. Basic rate is 7.5%, higher rate is 32.5% and additional rate is 38.1%.
So it’s a little more complicated here. Rather than delve into a convoluted example, my advice would be to estimate a sensible % provision based on what you believe your total income in the year is.
VAT
VAT is charged on taxable goods and services. It is known as a ‘consumption tax’. The normal rate is 20% but other rates do apply in some circumstances.
If you are a VAT registered entity, you should charge the appropriate rate of VAT on your sales, but you can also reclaim any VAT you have suffered on your purchases (unless on the flat rate scheme).
Time to annoy the bank manager again. Open up a separate savings bank account and call it ‘VAT Provision’ or something similar.
When you receive payment from your customer, put 20% aside (or whatever you’ve charged) into the VAT provision account. Similarly, take a look your purchase VAT in the month and claw back some of your VAT provision should you need it.
Corporation tax
Corporation Tax (CT) is the tax charged on profit (income minus allowable expenses) made by Companies. This is currently 19%.
Remember, CT is a tax on profit, not income. Therefore it’s not as simple as putting away 19% of what the Company brings in, because it depends on what you also pay out in expenses.
Open up a separate basic fee-free savings bank account and call it ‘CT Provision’ or something similar.
As a general rule, if your Company has a small cost base (e.g. a home-working IT Consultant), then put away close to 19% of your income (net of VAT if applicable) - you never know you might have a small surplus you can pay yourself at the end of the year.
If your Company has high sales but also high costs (e.g. a temporary employment agency) then take a look at your numbers in a typical month to see what your profit is compared to your sales (known as a profit margin). It might be that 5-10% of your sales would be an adequate provision.
Capital Gains Tax
CGT is a charge on the profit we make when we sell an asset (e.g. some shares or a property). For investment property, CGT should be calculated and reported at the point of sale. For anything else it is done via self-assessment.
This is an easy one to plan for.
Start with what you’ve received for the asset, deduct what you’ve paid for it, deduct any costs associated with buying or selling it, then finally take off the CGT tax free allowance of £12,300. If you have any gain left, it is taxed at 10% for basic rate taxpayers or 20% higher/additional rate taxpayers (18% / 28% respectively for property).
As usual, there are plenty of exceptions and nuances. However, applying this logic will get you most of the way there.
I hope that’s useful. Tax planning really is an important routine to get into, particularly during periods of instability such as now.
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