Tax…that well known four letter word!
Show me one person who is happy about paying tax…I think you’d be hard pushed to.
Before April, business owners could enjoy paying themselves dividends up to the higher rate threshold without paying any basic rate tax on this income. The 2016/17 fiscal year marked the start of a new dividend tax regime, specifically targeting shareholder directors who use high dividends in place of salary/bonus payments.
The salary versus dividend conundrum continues but despite this change, dividends are still likely to be the preferred option at the point where employer and employee National Insurance Contributions start to bite.
Add to the mix pension contributions! Since April 2016, the pension annual allowance will be potentially reduced from £40,000 to £10,000 for high earners. This will be triggered if all income (salary, bonus, dividends and investment income) is in excess of £110,000 PLUS the value of any employer or personal contributions. If the aggregated amount exceeds £150,000 the pension annual allowance will reduce by £1 for every £2 over this threshold, subject to a maximum reduction of £30,000.
If all income is less than £110,000 there will be no restriction in the level of pension contributions that can be made, subject to the annual allowance and any available carry forward allowance. So, with that in mind, it may well be more prudent to wait until the end of the tax year to make any significant pension contributions when (hopefully) it is known with greater certainty what income levels are likely to be.
How you pay yourself now will have even more crossover with the level of future pension contributions. The tax landscape is becoming a very rocky and complicated road with many changes in the area of personal taxation affecting different areas of financial planning.
For personal pension contributions it is important to make sure that the gross value of these contributions do not exceed the level of salary as tax relief can only be claimed up to 100% of salary.
There are many traps for the unwary! However, all hope is not lost!
The potential to channel funds through a working or shareholding spouse should also be considered to reduce the tax liability of the company owner and to maximise the pension contributions that can be paid. Furthermore, it’s best to try and keep the total income of the owner/manager below £100,000 to maintain the full personal allowance and avoid a 60% tax charge.
For those aged 55 or over there’s another avenue to consider, in terms of drawing pension benefits rather than salary/dividend as a source of income and making an employer pension contribution to compensate the pension fund for the drawn benefits. We will explore this option in more detail in a later blog.
So, there is scope to save significant amounts of tax but you need to know how to avoid the tax traps that lie ahead and maximise the opportunities that are available to you. After all, the benefit of reducing tax liability is to have more money in your pocket which you can spend personally, invest towards an end goal or give away as you please.