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Tax return season is here, and the deadline for sole traders is 31 January to pay any tax you owe for the financial year 2015/16.
It may be too late to reduce your upcoming tax bill, but there are some shrewd moves you could take to get a discount off your tax for 2016/17, and make sure you have more to retire on.
TAX ON DIVIDENDS
If you trade through a limited company, 2016/17 is the first year that you and any other shareholders will qualify for the annual dividend tax-free allowance of £5,000.
Previously for basic-rate taxpayers, any dividends you received would be considered as if you received them with a tax credit, so no further tax to pay. Now, basic-rate taxpayers pay an additional 7.5 per cent on dividends over £5,000, and higher-rate taxpayers pay 32.5 per cent tax. Ask your accountant whether it’s still worth trading as a limited company.
SAVE FOR A PROPERTY
If on 6 April 2017 you are aged between 18 and 40, you will qualify for the lifetime ISA. With this new type of ISA, for every £4 you save the government will add a £1 bonus, which can be used as a deposit for your first house or help towards your retirement.
The investment will grow tax-free. You can take your money out at any time, but if it is not to help buy your first property and you are under 60, the bonuses will be clawed back, plus any growth or interest and a 5 per cent penalty.
Nowadays, with so many grown-up children living with their parents longer to save for a deposit, contributing to a lifetime ISA could make their deposit grow faster.
Another option is the help-to-buy ISA. You can save up to £200 per month plus up to an extra £1,000 in the first month. The government will reward you with a 25 per cent bonus, so £200 becomes £250.
You can save up to £12,000 this way to achieve the maximum government bonus of £3,000. But, beware: drawing extra dividends or salary from your limited company to contribute to an ISA may increase your tax bill.
Pensions are a tax-efficient way to save for retirement, and growth is tax-free within the pension. Currently, pensions can be accessed at age 55 – expected to increase to 57 in 2028. With pension freedom, you can access the capital or draw an income, with 25 per cent of the capital tax-free under current legislation. The maximum a sole trader can contribute is the lower of £40,000 or your pre-tax profit. It may be possible to carry forward unused allowances from the past three years, but consider taking financial advice first. If trading through a company, seek advice from your accountant.
For sole traders, pension contributions are an easy way to reduce personal income tax. A £10,000 pension contribution costs only £8,000, because 20 per cent is reclaimed from the government in the scheme. Higher-rate tax-payers can claim up to a further 20 per cent in their tax returns.
For limited-company owners, pension contributions made from your company that are wholly and exclusively for the purposes of the trade are considered a business expense for tax purposes. Corporation tax is currently 20 per cent, so a £10,000 gross pension contribution means a corporation tax saving of £2,000.
There are no guarantees with pensions, so make sure yours is invested properly. Charges have come down enormously, so check the charges on any old pensions. Pensions are complex, though, and if you have any concerns, consider seeking professional financial advice which could save you costly headaches in the long term.
Chiltern Consultancy is authorised and regulated by the Financial Conduct Authority. Nothing in this article should be considered advice relating to your personal circumstances. Investments and pensions can go down as well as up and it is recommended that you see a financial adviser. The FCA does not regulate tax planning.
At the end of a year’s trading, it’s nice to think there will be some money left over. So what options are there to help plan for your future in a tax-efficient manner?
Michael Ross is a chartered financial planner at Chiltern Consultancy
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