Tax efficient

Introduction  

When you run your own UK company, how can you maximise your basic rate tax band in 2021/22? Also, at the same time, how can you also be tax-efficient? In this article, I am going to take a look at how you can do this. 

This article has helped plenty of UK contractors understand a lot better how to do this and a good accountant will guide you here. Maximising your basic rate tax band is also one of my handy tax tips for contractors and small business owners.

Firstly, it seems that the above is not always very well understood. 

Secondly, when I take on new clients, this is something that they do not always understand. On many occasions, their previous accountant did not explain this to them very well. What’s more, the method to work this out is not too awkward if you have the right info to hand. In conclusion, once you have read this through, you should be aware of how you can maximise your basic rate tax band. You should also be aware of how to be more tax-efficient when you run your own UK business. 

My tips   

If you are new to running your own company, a tip of mine is that it makes sense to claim for all of your genuine business expenses over the course of each year. This includes both a) rechargeable expenses to your client and b) non rechargeable ones. Expenses help to lower your company’s tax bill. Salaries are also regarded as expenses and these also help reduce company tax therefore from the outset you should consider what your salary is going to be and could also consider employing your spouse if they are going to be helping you run your company.

Besides taking a salary you can also take dividends from your company. Now, before I move on, there are many aspects to paying dividends. These include when should I pay them, the timing of paying them, how much can I pay, the dividend allowance and illegal dividends.

Being tax efficient 

One thing that does come up quite often from directors is how I can be tax-efficient? Well, the answer is you need to know:

  • What the current tax bands and allowances are. 
  • How the above will interact with taxable income. 
  • What the current tax rates are 
  • How you apply the above to different sources of income  

In summary, the tax bands and allowances and, indeed, tax rates all change over time. Therefore, if you would like to maximise your basic rate tax band be tax-efficient, you need to know how your tax bands work and how your income is taxed.

Recent tax changes in the UK

Although we are looking at how to maximise your basic rate tax band, let us have a look at some other recent UK tax allowance changes.

One recent change was the complete overall of the UK dividend system. Before April 2016, the dividend that individuals received was 9/10ths of the gross, and you received a 10% tax credit. However, from April 2016, the government scrapped this and brought in the tax-free dividend allowance of £5,000, and this stayed in place for 2016/17 and 2017/18. In the next tax year in 2018/19, the government chose to reduce this allowance to £2,000, and this is still the case for 2021/22.

A further example of a recent change is before April 2016 interest income was tax at source (20%). However, after April 2016 you now receive interest tax-free but:

  • Basic rate (20%) taxpayers –they can earn £1,000 interest per year with no tax (therefore this gives a max tax saving of £200 compared with the time before this) 
  • Higher rate (40%) taxpayers –they can earn £500 interest per year with no tax (therefore this gives a max tax saving of £200 compared with the time before this) 
  • Additional rate (45%) taxpayers -they can earn £0 (they do not receive a tax allowance) 

A brief history

First of all, the personal tax allowance and basic rate tax band usually change every year. Most important, over recent years, the personal allowance has been increasing. Meanwhile, the basic rate tax band has been increasing too. However, this was not always the case, as is shown in the table below.

  • First, please note, in recent tax years in the UK, there have been different allowances and tax rates that apply in Scotland. Wales and Northern Ireland also have their tax allowances and tax rates, but these currently align with England. 
  • Please also note, in recent times, the government brought in separate rates and tax bands for savings. These will indeed need taking into account if you have sizeable savings. 
Personal Allowance Basic Rate tax band Total that can you can earn before higher rates tax applies (this is the level of income where you would maximise your basic rate tax band in previous years)
2021/22 £12,570 £37,700 £50,270
2020/21 £12,500 £37,500 £50,000
2019/20 £12,500 £37,500 £50,000
2018/19 £11,850 £34,500 £46,350
2017/18 £11,500 £33,500 £45,000
2016/17 £11,000 £32,000 £43,000
2015/16 £10,600 £31,785 £42,385
2014/15 £10,000 £31,865 £41,865
2013/14 £9,440 £32,010 £41,450
2012/13 £8,105 £34,370 £42,475
2011/12 £7,475 £35,000 £42,475

In the future, the personal tax allowance and basic rate tax band will carry on evolving. What’s more, when you are running your own business, it is good to know what you can earn to maximise your basic rate tax band and what tax you will need to pay upon this and indeed how to be tax efficient.

2021/22 tax year

When you maximise your basic rate tax band, you could take the full £50,270 earnings and stay within your basic rate tax band. Please note, your company needs to be earning enough profit to pay you the £50,270.

Therefore, the maximum that an individual can earn in 2021/22 before paying higher rates tax is £50,270.

To sum up, when you run your own business, you can take your earnings as a combination of salary and dividends. This blend of income enables you to be tax efficient. When you are employed, you do not have this option.

Suggestion

To maximise your basic rate tax band and take-home pay and also be tax-efficient at the same time you could:

  • Take an annual salary of £9,564 -please note this is enough to count as a qualifying year for UK state pension purposes. The £9,564 equates to £797 per month 
  • Take total annual dividends of £40,692. In turn, this equates to a dividend of £3,391 per month 
  • As a result, if you add together the £9,564 annual salary and the £40,692 annual dividend, this would give total earnings of £50,256. This way is the most tax-efficient mix if you have your own business, and your total income is just under £50,270.   

Tax allowances

When looking at how to maximise your basic rate tax band, the personal tax allowances that are available to you in 2021/22 are as follows:

  • Your tax-free personal allowance is £12,570
  • Your tax-free dividend allowance is £2,000 

Working out the tax and take-home pay

When you maximise your basic rate tax band, in working out which tax bands cover which types of income you need to note:

  • Your personal allowance covers the £9,564 salary that I show above. 
  • First, you need to take your personal allowance of £12,570. Next, deduct from this the £9,564 above. The result is £3,006, and therefore £3,006 worth of your dividends are also covered by your personal allowance. 
  • Secondly, your annual dividends allowance covers £2,000 worth of your dividend income. 
  • Finally, take the dividend figure above of £40,692 and deduct the £3,006 and £2,000 above and this leaves £35,686. If you multiply this by the basic rate tax rate on dividends (7.5%), it gives £2,677. 
  • In conclusion, the tax-efficient result is the £2,677 will be your personal tax bill that will be payable via your Self Assessment tax return at a later date. 

Monthly earnings and tax savings

When you maximise your basic rate tax band, as shown above, this will result in:

  • First, you can take a monthly salary of £797; 
  • Second, your monthly dividend is £3,391; 
  • But, you will need to save £2,677 divided into 12 = £223.08 per month to cover your personal tax that you will need to pay later on. Personal tax is payable to HM Revenue & Customs via your Self Assessment Tax Return
  • In short, £797 plus £3391 minus £223.08 = £3,964.92 net earnings each month -you have maximised your basic rate tax band; 
  • To sum up, this will leave the director’s gross income just under £50,270 pa. 

Other income 

Please note, when you maximise your basic rate tax band, you might have other income. Such income could include rental profits, bank interest, or other dividends. Therefore, the above will need working out again to ensure that you are tax efficient.

Higher rates tax

You can maximise your basic rate tax band as described above, however, if you as an individual, personally earn more than £50K:

  • Dividends that fall in the higher rates tax band, i.e., above £50,270, are taxable at 32.5%. 
  • Also, if you earn above £100,000 as your personal taxable income, you start to lose your personal allowance the more that you earn. You will effectively lose £1 or your personal allowance for each tax-adjusted £2 that you make above this. 
  • Finally, the tax rate will increase to 38.1%. It will apply to dividends above a personal taxable income of £150,000. 

Final thoughts

My article above shows the position quite well for 2021/22 in terms of how to maximise your basic rate tax band and, at the same time, be tax efficient. However, you would indeed need to do further workings if you have any other sizeable sources of other income.

There could also be further things to consider if you live in Scotland and are subject to the Scottish tax bands.

Going forward, I will continue to update this article in the future when the UK tax allowances, tax bands, and rates change.

Furthermore, besides showing how you can maximise your basic rate tax band, there are many other good reads on this website. These cover how salary, dividends, expenses, profit, and other areas work. They also include different ways of how you can be tax-efficient and what to watch out for when running your own business.

As an aside, if you have worked at several different employers in the past and have various pension schemes, something that you may be interested in is pension consolidation.

In conclusion, I hope you enjoyed the article!

Link to Contractor Advice UK group on 

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