One of the advantages of running your own business – whether it be a sole trader operation or a large limited company – is that you can take advantage of a number of tax benefits.
We are not talking about tax evasion or even avoidance (the latter being legal but frowned upon).
What we are talking about is simply knowing how to carry out your business in the most tax efficient way.
This means taking advantage of tax breaks and schemes that have been put in place by the government to encourage and support businesses.
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Tax Efficiency for Sole Traders: A Quick Overview
At the most basic level of tax efficiency you need to ensure that when filing your self-assessment, you are declaring all costs that have been incurred by your business activities.
This includes cash purchases – something many sole traders overlook.
Whilst it may only seem like a small amount for that pack of envelopes you bought – it soon adds up and will reduce your declared profits and therefore your tax bill.
You also need to know what you can, and cannot claim as there are several things you can claim for as expenses.
For example costs of up to £6 a week for your utility bills (for current rates, see here) will not be questioned if you work from home. If you use your car for business use you may be able to claim for part of the costs of running it.
Tax Efficiency for Limited Companies: A Quick Overview
As a limited company you can use many of the same tax efficiency practices as sole traders in order to reduce your liability.
This includes claiming back cash purchases as expenses, claiming for the cost of working from home, and the usage of your car for business use.
However, there are a number of other tax-efficient benefits you can take advantage of.
By far, the biggest one is to pay yourself a low regular income via PAYE but to take larger dividends on the company profits.
This is usually more efficient as, although you will pay corporation tax on company profits, you’ll only pay tax on dividends based on your income tax band (current rates can be found here) and you’ll get a certain amount for free (currently £2,000 per year).
Any amounts you pay yourself as PAYE salary can be deducted from your profits (saving money on your company tax bill).
This is one of the biggest advantages of a limited company and by paying yourself a salary only equal to the threshold and taking the rest as dividends will usually save you a lot of money over the course of a year.
What’s more, you can pay yourself a dividend as often as you wish providing that the correct paperwork has been drawn up each time.
How Can A Small Business Reduce Taxes?
If you are a sole trader then it’s simply a case of finding out what you can and cannot claim for and making use of it the best way you can to embrace tax efficiency.
Unfortunately, the HMRC do not provide a guide outlining all the benefits you can claim. It’s up to you to find out, although we have mentioned the main ones in this article.
If you are a limited company, then you would be strongly advised to consult with an accountant.
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A good accountant will save you money as they will be fully up to speed on all the current tax efficiency procedures and be aware of how you can take advantage of them.
The exact benefits and how much you stand to gain does change from year to year so you (or your accountant) will need to constantly remain aware of where the tax efficient benefits are for you and your business.
Once in place, you can set about running your business safe in the knowledge you are operating in the most profitable way as possible.
Of course, depending on the type of business you are running, or the level of income you are generating, you may need to look at VAT registration as your next efficiency step.
What Percentage Should A Small Business Save For Taxes?
This is a question that new business owners often ask. It can be quite daunting to know your business is generating a bill that won’t be payable for some time.
In fact, some taxes are due months after they were incurred. In the case of corporation tax, any money owed doesn’t need to be paid until 9 months and 1 day after the end of your accounting period.
That means tax you incur now, may not be payable for another 21 months!
While that sounds great in principle, it does mean you have to set aside enough money to cover your future payments. Failure to do this can be catastrophic to your business. Any missed payments will almost certainly incur financial penalties or legal action.
As a minimum, a small business should be saving around 20% of it’s monthly profits to pay a corporation tax bill. The exact amount will depend on the rates applicable to that business. This can be checked, here.
Keep in mind that your business may have other tax and fees to pay. You as an individual may also have to pay further money on your self-assessment. It is, therefore, worth keeping a close eye on how much tax you need to pay and when, so you can always ensure you put enough money aside.
Using Accounting Software To Calculate Tax Payments
Thankfully, it is now much easier to keep on top of your finances, and implement different tax efficiency strategies you wish to by using online accounting software. Using such software gives you numerous benefits:
- It helps you fulfil all your bookkeeping requirements
- It saves money on your accountancy fees as everything will be better organised
- It automatically calculates tax as you go, helping you plan your finances better
- You’ll usually get alerts when bills are due, so you never miss a payment
It’s easy to see why so many people are using accounting software. Most software will also help to create all the legal documentation you need (such as records of dividends paid).
Previously, people would need to do this manually or pay an accountant to do it so it’s both a time and cost saving.
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