For the 2019/2020 tax year, tax allowances and rate bands have increased. In this article, we demonstrate what that means to contractors in real terms, and offer our advice for trading as tax-efficiently as possible.
3 ways to trade tax-efficiently for 2019/2020
1. Use the optimum salary levels for 2019/20.
There are two main scenarios for optimum salary levels. In the majority of cases, the salary level should be:
- £12,500 if you have more than one employee in the Company (e.g. a spouse). Having more than one employee through the business will mean you can continue to claim the employment allowance. This will reduce the employer’s National Insurance payable.
- £8,632 if you are the only employee in your Company. The employment allowance is withdrawn where the Director is the sole employee. A salary of £8,632 will still give you a qualifying year for state pension entitlement.
Corporation Tax relief is available on the salaries as they are treated as a business expense. The salary levels are below the personal tax free allowance.
2. Increase the amount of dividends being taken from the Company.
The basic rate tax band has increased to £50,000. This means you can have total income of £50,000 before you pay higher rate.
With the increase in the higher rate tax threshold, more dividends can be taken from the Company before hitting the 32.5% tax rate. The optimum amount of dividends for most people in each tax year will be:
- £37,500 per year (6 April to 5 April) or £3,215 per month, if on a salary of £12,500 per year.
- £41,368 per year (6 April to 5 April) or £3,447 per month, if on a salary of £8,632 per year.
You must take account of any other income you receive and reduce the dividends accordingly if you want to remain below the higher rate tax threshold.
3. Don’t take more out of the Company than you need.
The main tax planning opportunity for limited company contractors has not changed. You have the flexibility to decide how much tax you pay by increasing or decreasing dividends. The most tax-efficient method will be to take dividends and salary based on the advice in points 1 and 2 above and for any extra profit to be left in the Company if not needed.
What happens to the money saved within the Company?
You have a few options with this:
- Make investments in the Company name e.g. shares, bonds, property. Although it is worth getting advice from us first to ensure the trading status of the company is preserved.
- Make other larger one off dividend payments and paying the higher rate (32.5%) or additional rate (38.1%) tax. There are ways to mitigate this as well. For example income tax relief on EIS, SEIS and VCT investments.
- Leave the money in the Company. When you come to cease contracting you could either:
- Draw out £2,000 per year tax free
- Liquidate the Company and draw out the total profits in one lump sum at 10% tax rate using Entrepreneurs Relief subject to the new 2 year rule.
4. Contribute to a pension scheme. This option is becoming more and more appealing now – especially for those approaching 55 who could draw down on it at that age. The tax relief is two-fold; the Company would receive Corporation Tax relief at 19% and you, personally, would draw less from the business in dividends.
What else do I need to think about?
Payments of dividend tax
The tax on dividends is a personal tax liability and will be payable annually as part of your Self Assessment tax return calculations. This will be due by the 31 January following the end of the tax year. Once you have taken account of any other income, tax on dividends is at the following rates:
The first £2,000 in dividends will be tax free. Above this dividends will be taxed at:
7.5% for basic- rate tax payers (on dividends falling below £50,000)
32.5% for higher-rate tax payers (on any dividends above £50,000 per year)
38.1% for additional-rate tax payers (on any dividends above £150,000 per year)
Payments on account
If you had not paid tax (or had a liability below £1,000) under Self Assessment previously then you will have to make the payment for the previous year plus payments on account in respect of the current year. So if you had a liability of £2,000 for the year ended 5 April 2019, your tax payable would be:
Due 31 January 2020 – £3,000.00 made up as:
£2,000.00 – balance of tax for the year ended 5 April 2019 (but reduced by payments on account made previously)
£1,000.00 – 50% of tax for the year ended 5 April 2020
Due 31 July 2020 – £1,000 made up as:
£1,000.00 – remaining 50% of the tax for the year ended 5 April 2020
Corporation Tax Rate
The Corporation tax rate will remain at 19% from April 2018 but is expected to reduce to 17% from April 2020.
What are the next steps?
Ahead of the new tax year we will be taking a look at each of our client’s individual circumstances and adjusting salary levels to the most tax efficient levels as below:
- £12,500 per year if more than one employee through the Company
- £8,632 per year if only one employee through the Company
The payroll summary will be emailed at the start of the new tax year in April 2019.
With over 20 years’ experience in the contracting sector, we class as ourselves as experts in handling contractor accounts.
If you’re ready to take the step into contracting, click here to download our free guide to contracting. Or, speak to one of our directors on 01962 867550 to find about our monthly accounting packages.