£4.8 billion is overpaid in tax by cash strapped Britain – tax which could easily be avoided (source: Unbiased.co.uk). If you include unclaimed tax credits this rises to £13.5 billion.
Without the right strategies, dentists risk being part of this tax waste, over-paying tax and being unprepared for the future.
Danny Cox, head of advice at Hargreaves Lansdown, provides his top tips to help dentistry business owners.
Minimise tax – the family tax bill
Where possible, business income and personal financial affairs should be structured to use both spouse’s tax breaks and allowances.
Everyone is able to receive taxable income of £7,475 (2011/12) before income tax is paid and, at age 65, this rises to £9,940 (2011/12) due to the additional age related allowance. Combine the two for a couple and the tax-free household income could be as high as £19,880 (2011/12). This is a tax break well worth planning in advance for. Please note that if an individual’s taxable income exceeds £24,000, the age allowance is lost at a rate of £1 for every £2 income.
A sole trader (or partnership) where profits exceed around £42,475 might be able to pay less tax if the business is transferred to a company. The income tax rate for individual earnings above £42,475 is at least 40%. This compares to the small profits rate for a company at 20%.
Incorporation also allows flexible and potentially more tax efficient director remuneration – part salary, part dividends, perhaps director loan accounts – which can save income tax and national insurance contributions. However, there are higher administration costs associated with running a company.
Save for retirement
Pension contributions are one of the most tax efficient ways to save for retirement. The contributions are normally full deductible against profits as a business expense and are not subject to national insurance contributions. Furthermore, the pension fund itself grows free of capital gains tax.
Contributions are capped at £50,000 per annum, although there is now a carry forward facility – the ability to catch up unused contributions from the previous three years.
Incorporated businesses should normally fund dentist’s pensions through employer contributions.
Personal pension contributions can also be made for non-earning spouses up to £3,600 per annum at a net cost of £2,880. Pension income is one of the best ways to use up tax-free personal allowances at retirement.
It makes sense to build other assets and investments outside of the business for diversification. After building an emergency fund using tax-free Cash ISA, stocks and shares ISAs could be the next progression.
The ISA allowance is £10,680 for 2011/2012 of which £5,340 could be cash. ISAs have a number of different tax advantages: they are capital gains tax free and virtually free from income tax. Therefore an ISA portfolio is often used to generate tax efficient income to supplement pension income in retirement
Plan ahead – capital gains tax v income tax
Generally speaking, the rate of capital gains tax paid is lower than the rate of income tax paid. Capital gains tax is paid at either 18% or 28% depending upon your taxable income but only after profits exceed £10,600 the annual capital gains tax allowance.
Therefore hold high yielding shares or funds in ISA and low yielding funds or shares outside.
For business shares, Entrepreneurs Relief reduces the capital gains tax rate to 10% on their first £10 million of lifetime profit.
There are times when paying for professional advice makes sense. Setting in place the right structures and tax strategies, for both personal and business affairs, should minimise tax liabilities over the years and could reap significant rewards.
Tax rules are subject to change and their value and benefit will depend upon individual circumstance. If in doubt seek professional advice.
For more, visit www.hl.co.uk/dentist.