January 31 has been and gone, and many business owners are still reeling from the sting of a higher-than-expected personal tax bill.
It’s never fun when that brown envelope from HMRC lands on your doormat, stating in no uncertain terms that you owe £X when you were expecting £Y.
But what can you do about it? There’s little point arguing after the fact, so it’s time to get prepared for next year’s bill. And in this blog post, we take a look at three simple steps to avoid the shock of another eye-wateringly large number leaving your bank account.
How Can I Reduce My Tax Bill?
Step 1. Understand What You Owe
One of the main culprits when it comes to surprise tax bills is something called payments on account.
It will typically catch out individuals in their first year of trading, but it’s a tricky little complication for even the most seasoned of business people.
Here’s how it works: When your tax bill passes the £1,000 threshold, you will be required to pay an advance of next year’s tax bill, half of which is due on January 31, with the second instalment due on July 31.
Each payment is calculated as half of the previous year’s tax bill, based on your combined tax and National Insurance contributions (NIC).
For example, if your total tax bill for 2017-18 was £3,000, each payment on account for 2018-19 would be £1,500. So, instead of paying £3,000 as expected on January 31, you’re actually paying £4,500. And suddenly you’re faced with a cash flow problem and a demand for payment from an organisation who don’t take too kindly to non-payers (we’ll explain what you need to do if you can’t pay later in the post).
If your profit varies from year to year, the payments on account will vary too. You might need to overpay one year, in which case you’ll receive a refund, or you might underpay, in which case you’ll
be charged interest. You do have the option to use the refund to offset against a future tax bill on your tax return, which can give you some breathing room when the next bill arrives.
Why does this payment exist?
From your point of view, asking for 18 months worth of tax in one lump sum might seem like overkill, but if you put yourself in HMRC’s shoes, it does make sense.
If you were working in a typical job where PAYE is deducted monthly, the government will receive your tax and NIC the very next month. However, if you’re submitting your own tax return, your bill is due to be paid the following January. This means it can take months or even years before the government receives tax on the money you’ve earned.
Why does this payment exist? From your point of view, asking for 18 months worth of tax in one lump sum might seem like overkill, but if you put yourself in HMRC’s shoes, it does make sense. If you were working in a typical job where PAYE is deducted monthly, the government will receive your tax and NIC the very next month. However, if you’re submitting your own tax return, your bill is due to be paid the following January. This means it can take months or even years before the government receives tax on the money you’ve earned.
Payments on account was introduced to shorten that time between self-assessment tax payments by almost a year.
And don’t forget NIC
Your Income tax is calculated as 20% of your net profit less your personal allowance, on earnings up to £45,000 (Basic rate), 40% on earnings between £45,001 and £150,000 (Higher rate), and 45% on earnings over £150,000 (Additional rate).
Where many business people leave themselves open to yet another surprise addition to their personal tax bill is in forgetting that they will owe Class 2 and Class 4 NIC, to be calculated and collected at the same time. Make sure you’re factoring those into your calculations.
Step 2. Start Saving Now; Switch to the Cloud
You’ve experienced the shock of a huge tax bill, and it wasn’t nice. And the only way of avoiding yet another nasty surprise next time around is to plan for next year.
Start by setting aside some time each month to review your bookkeeping activities. If up until now you’ve been reactive to the money you’ve earned, it’s time to be proactive. Calculate your profits, forecast your cash flow, and start saving money for tax. There’s little point in sweeping all of your earnings into your personal bank account if you’re only going to leave yourself short come the following January.
And now that you’re well aware of payments on account, you can make sure you’re saving more each month to keep yourself covered.
Make the switch to cloud accounting
If you haven’t already, then now’s the time to embrace the cloud. Using a cloud accounting platform such as Xero, you can further enhance the accuracy of your savings by seeing a real-time view of your financial performance. Quickly calculate your take-home pay less expenses and estimated tax, and make sure you’re putting enough aside to meet your liabilities.
Plus, it’s good practice to build a cash reserve should you run into a particularly challenging cash flow situation.
Step 3. Work with a Tax Expert
Now that you understand what you owe, and you’ve started to build your savings, the next step is to learn how to minimise your tax liabilities throughout the course of the current tax year.
Of course, this can be very challenging, especially as you have a business to run, and you won’t always have time to dig into the allowable expenses related to your industry.
That’s why we recommend you lean on the expertise of a tax advisor. They can help you identify tax saving opportunities of which you were perhaps unaware.
And it should come as little surprise that those business people who typically receive lower tax bills are the ones who remain proactive and organised throughout the year, working closely with their accountants to pinpoint savings and claim for the correct expenses.
Follow their lead and you too will avoid another scary tax bill.
What If I Can’t Pay?
If you can’t pay your tax bill, first thing’s first: Don’t panic.
It’s important that you submit your tax return as normal, otherwise, you will be fined. And the longer you leave it, the larger the fine.
Next, discuss the situation with HMRC. They’re not your enemy, even if they’re the ones after your hard-earned cash. They’ll take you through your options, and you may be given the opportunity to either delay your payment or pay via instalments.
Bookmark this link, just in case.
Avoid the Shock with Saint & Co.
Following steps, one and two will shape your understanding of, and relationship with, tax.
Following step three can bring your bill down. And we can help you take that step.
From offering expert advice to keeping you organised and minimising your liabilities, our friendly team is ready to change your approach to tax. And together, we’ll make this the last year you received a shock tax bill!
Simply fill out our contact form, or call us on 01228 534371 to get started.