Income Tax – you can control it, even reduce it!
A Company Owner can ultimately decide whether any distribution of the company’s money is classified as salary or dividend. You essentially have complete control over how much income you withdraw in total. This gives you a significant amount of power over your personal Income Tax bill.
Sole Traders pay tax every year on ALL the profits of the business. However, Company Owners only pay Income Tax on the money they actually withdraw from the company. This allows Company Owners to reduce their Income Tax bills by adopting the following strategies:
• ‘Smooth income’
• ‘Roller-coaster income’
The Company Owner withdraws roughly the same amount of money each year, even though the company’s profits may well fluctuate.
‘Smooth income’ allows the director/shareholder to stay below the following Income Tax thresholds, that could result in a higher bill:
The directors/shareholders take a bigger or smaller salary or dividend than what would normally be required to fund their lifestyles.
Here’s how the ‘Roller-coaster’ income strategy can save you tax:
Up or Down Tax Rates
If tax rates rise during a future tax year, you may wish to pay yourself more income now and less income later on.
If tax rates fall during a future tax year, you should pay yourself less income now and more income later on.
Avoid Capital Gains Tax
Company Owners may wish to pay themselves less income during tax years in which they sell assets subject to capital gains tax, e.g. rental properties.
This may allow some of your basic-rate band (£34,500 in 2018/19) to be freed up, and some of your capital gains will be taxed at 10% or 18% instead of 20% or 28%.
If you intend to move abroad and become non-resident in the future, you could consider withdrawing less income from your company while you are UK resident. Then, more income after you become non-resident.
Providing you move to a country with favourable Income Tax rates, this strategy could potentially save you significant amounts of UK Income Tax.
When you reach age 55 you may decide to start withdrawing money from any private pension scheme you belong to. Any amount you withdraw over and above your 25% tax-free lump sum will be subject to Income Tax.
Fortunately, with a drawdown arrangement you can vary the amount of income you withdraw from your pension scheme every year. There are no limits placed on the amount of income you can withdraw.
You can vary the amount of income you withdraw from your company. This could allow you to minimise your Income Tax bill by staying below any of the Income Tax thresholds listed above.
For more information, we provide a Business Consultation to fulfill all your business needs.
We have created several posts surrounding the small salary, big dividends tax planning technique including potential dangers, non-tax factors and National Insurance for further reading here.