Hi, I"m Graham from Inca Chartered Accountants. One of the questions we get asked most frequently from our clients — “How much tax will I pay?" Well, as soon as your accounts are done we will know to the penny, but of course that may happen several months after your financial year end. And it"s great to have an idea of how much tax you are likely to pay well in advance of that. So what I"m going to show you is a way to estimate your tax liability. It is only an estimate. We won"t know for sure until your accounts are done but it will give you something as a guide as you look ahead through the course of the business year.
The amount of tax you pay is dependent upon the type of business you operate. So in this video we are going to look at the two main types — the sole trader and the limited company.
If you are a sole trader you can earn roundabout £7,500 a year in profit, not sales, that"s your sales and then take off your costs and your not going to pay any tax on that money. But as soon as you go above that level you are going to start paying tax at a rate of 20%, the same as somebody in employment. But you are also going to have Class 4 National Insurance. Now that kicks in at 9% making your total tax hit 29%. Now the Class 4 National Insurance is interesting because people think my National Insurance – I get a pension, I get hospital cover. Yes, you have already paid for that in a direct debit that goes out of your account every month. This is just tax. You do not get any extra benefit from having paid it.
So in order to work out how much tax you have to pay we need to look at your profit month-on-month. You take your sales, subtract your costs, not your drawings, that"s money you take out. Put them to one side for the moment. Once you have got that profit situation in place, £600 every month that"s yours free, nothing to worry about. But after that £600 you need to put nearly a third away. That is one third for the government, two-thirds for you. Stick it in a cash ISA. It gets paid in January of each year, but be careful because you may also have what is known as a payment on account if your tax bill is high and that"s going to kick in, in January and July .
Now the Limited Company is completely different because you are not taxed. It is the company that is getting taxed. And the company does not have any tax free amount that it can earn year after year. Company pays tax as soon as it makes £1 of profit and it pays tax at a rate of 20%. That"s 20% on all its profits way up to a quarter of a million pounds approximately. Now that"s a 9% saving for most average earners. That"s most significant. A company has to pay its tax 9 months after its financial year.
So calculating it.
You take your sales subtract the expenses the business incurs. That"s your costs, salary perhaps, supplier invoices and that gets you your profit before tax comes off. Then put 25% away to be on the safe side. So it"s a quarter for the Government and three quarters for you. That"s what you can have as your dividend income.
One of the pit falls of many businesses get into. They think there"s my profit, I"m going to take a dividend and get a tax on the dividend. Now that"s wrong. Tax gets paid on the profit and then it"s your bit. The dividend – that comes afterwards. Remember what I"ve just told you. It"s about estimating your tax bill. If you want to know exactly how much tax you are going to pay send us your accounts.
In the next video I"m going to talk about How to get a dividend out of your company.