With tax increases looming, it is ever more important you look at how you are managing your personal finances and practice, and consider how you might reduce your taxes or improve your financial and business strategies. Tax planning involves taking advantage of allowances and exemptions including deductions for pension contributions and capital allowances. However, with the change in Government, there is also change to the amount we are taxed.
In regards to your practice, it is important to help your profits by selecting an accounting date. This decision will affect the delay between the profits earned and the tax paid on those profits.
However, if your practice has:
- static profits; this delay is not an issue.
- rising profits; the delay provides a useful cash flow benefit.
- falling profits; the delay makes tax payment difficult if practice needs have eroded cash that might have been set aside to pay tax.
In addition, it is worth noting that while an accounting date made early in the tax year can benefit a growing practice, the current economic conditions mean many practices might benefit from a change in accounting date to ensure lower profits come into charge earlier, reducing tax payments. This may not be so attractive when profits rise again, however.
Another aspect you should consider is the National Insurance contributions. Though these are very costly, salary can be deducted from taxable profits earned by the practice, making very little difference between extracting profits by way of salary or dividend for higher rate taxpayers.
Personal allowance
Personal allowance is a major aspect you also need to look into. It should be noted any unused personal allowance at the end of the tax year cannot be carried forward. Therefore, you should make sure, as far as possible, allowances are covered by your income every year.
As the personal allowance for 2010/11 is £6,475 (like the previous year), you will want to guarantee that it is fully utilised. It is worth noting that the allowance rises to £7,475 in 2011/12.
Where dividends are concerned it is important to know tax credits cannot be repaid on them, so dividend income cannot be used to cover personal allowances. A higher rate (40 per cent) taxpayer must pay another 25 per cent tax on net dividends. From April 6, 2010, an additional rate (50 per cent) taxpayer must pay another 36.11 per cent tax on net dividends. This can allow you to save if dividends are transferred from higher rate taxpayers to basic rate taxpayers.
If you are 65 or over, your personal allowance is £9,490, yet, this allowance is reduced to the normal personal allowance if your income is over £22,900, as £1 of additional allowances is withdrawn for each £2 of income over the limit. Taxpayers in this position will experience a marginal rate of 30 per cent tax on income between £22,900 and £28,930. It is therefore particularly beneficial to transfer income to a partner in this band.
A similar problem arises for any tax payer earning between £100k and £112,950. Due to a reduction in the personal allowance by £1 for every £2 earned over £100k an effective tax rate of 60 per cent applies to any earnings in this bracket.
Those who are affected by this have other means of reducing their income for the abatement calculation. For instance, making donations to charity or making contributions to a pension:
- small donations to charity during the year can mount up and it is important you keep a record of all the donations you make to ensure you receive the full benefit for them.
- when contributing to a pension, you can pay up to £3,600 in any year which you have no earnings. You can potentially save tax at 20 per cent, but also the pension benefits can be drawn immediately by taking a 25 per cent tax free lump sum.
Pension contributions
Where pensions are concerned, there have been a great many changes that need to be addressed when planning for end of year tax. For example, last year income tax relief was restricted to anyone with an income above £150k. Then this changed so there would be further restrictions for anyone with an income above £130k though this would only be in effect as of April 6, 2011.
However, after the election, the new coalition Government decided these plans were too complex and subsequently decided to alter them, while still defending the revenue from the tax change. As of April 6, 2011, the annual limit will be reduced from £255k to £50k so taxpayers still receive full income tax relief on pension contributions up to £50k a year. Additionally, the lifetime allowance will be reduced from £1.8m to £1.5m from April 6, 2012.
There is now an annual limit on pension contributions made by or on behalf of individuals. Contributions above this limit result in a tax charge, currently at 50 per cent. Below this annual limit, there are both potential restrictions on tax relief and a sliding scale of tax charges depending on the level of income as defined for pension purposes.
Professional advice should be taken to ensure the tax implications of all contributions made are fully understood so the relevant planning measures can be taken. This is important to ensure that you are not paying more tax than you should or losing out on any possible tax breaks in the tax year ending on April 5, 2011.