2010/2011 Tax Year End Planning
February is a good time for individuals to have a think if there are any simple steps they can take to minimise their tax liabilities.
It is probably the case that owner managers have the most opportunities available, but there is certainly some scope for tax planning for the self-employed and employees.
In this article I consider some of the planning ideas that individuals can consider and I also look at the some of the changes taking place to the system for the 2011/12 tax year.
A useful starting point is to look at allowances and tax bands.
The Personal Allowance
This is the amount of gross income an individual can receive before paying tax for the 2010/11 year it is £6,475
The Basic Rate Tax Band
This is the amount of taxable income over and above the personal allowance, which is just taxed at the basic rate (20%). For the 2010/11 year it is £37,400.
The Higher Tax Rate
Taxable income between £37,400 and £150,000 is taxed at 40% and taxable income above £150,000 is taxed at 50%
The Personal Allowance Taper Level
This is the level of gross income an individual can have before his personal allowances start to be tapered away at £1 for every £2 of additional income. It is set at £100,000 and means that individuals whose income is between £100,000 and £112,950 face an effective marginal tax rate of 60%
The Capital Gains Tax Threshold
This is the level of capital gains an individual can make in a tax year before paying capital gains tax. For the 2010/11 year it is £10,100. Capital gains tax is charged at 18% for basic rate taxpayers and 28% for higher rate taxpayers. A reduced rate of 10% can be claimed in respect of gains on certain business assets.
The Lower Earnings Limit
This is the minimum salary a person can earn in order for that year to count towards his state retirement pension. For the 2010/11 year it is £97 per week (for each of the 52 weeks) or £5,044 for a director who is employed for the whole year. An individual needs 30 such years to qualify for a full state pension.
The Primary Earnings Threshold
This is the level of earnings at which National Insurance becomes payable. For the 2010/11 year it is £5,715, or £110 per week. Above that level employees NI is calculated at 11% and employers NI at 12.8%. The self employed pay 8%.
The Upper Earnings Limit
This is the level of earnings at which the employee’s liability drops from 11% to 1% and the liability for the self employed drops from 8% to 1%. For the 2010/11 year it is £43,875
TAX PLANNING AREAS
I list below some areas where individuals may find that they can reduce their liabilities by taking action now.
Salaries for Owner Managers
Most small company directors are aware that they will probably benefit from a low salary/high dividend profit extraction. But what is the optimum level of salary? The problem is that for a director with no non company income, personal allowances are lost if salary is below £6,475 but National Insurance is paid if salary exceeds £5,715. So which is best, £6,475 or £5,715? The answer is £5,715, so a director drawing a salary of say £550 per month would benefit by not drawing salary for February and reducing March salary to £215, compensating for lost income with an additional dividend.
Optimum Dividend Levels for Owner Managers
A small company director with no non company income can receive gross income of £43,875 before paying higher rate tax. Dividends are received net of a Notional 10% tax and so dividends should be divided by 0.9 to convert to gross income. For a director receiving a salary of £5,715, dividends of £34,344 will exactly use his basic rate tax band (assuming no non company income).
At a higher level a person with gross income between £100,000 and £112,950 will face the 60% tax trap. Assuming no other income and a salary of £6,475, dividends of £84,172 will take gross income to £100,000. The marginal rate on net dividends just in excess of this will be 43% compared to a 25% rate where income is just below £100,000. So it is well worth trying to ensure that gross income, including dividends, does not fall between £100,000 and £112,950. This point is equally relevant to employees and the self employed who have earned and other gross income close to £100,000 and who also receive dividends perhaps from listed shares.
At a higher level still, the 50% rate starts where gross income exceeds £150,000. This total would be reached by, for example, a salary of £10,000 and a dividend of £126,000. An individual with such an income considering a further dividend now should consider deferring that dividend until after 5th April 2011.
Pension Contributions
It is, of course, well known that pension planning offers generous tax breaks. But for those whose gross incomes are expected to slightly exceed £43,875, £100,000 or £150,000, a personal pension contribution is well worth considering. For example, a person whose total gross income this year will be £110,000 can reduce his tax liability by £6,000 by making a gross contribution of £10,000 to a pension scheme. If he is 55 or over, he has instant access to 25% of this premium as a tax free lump sum, and so he can find that he has £7,500 invested in a pension fund for a net outlay of £1,500.
Individuals with high gross income and existing pension contributions need to seek professional advice before making pension contributions because of complex anti avoidance legislation introduced by the last government. Gift Aid contributions reduce gross income in exactly the same way as pension contributions.
Capital Allowances
The self employed can reduce their taxable income by investing in plant for their business before the end of their accounting period. For example, a self employed solicitor making accounts up to 31 March 2011 who expects his profits to be £112,000 could reduce his liability by £7,200 by investing £12,000 in plant before 31st March 2011. So if he was planning to replace his computer system in the near future, there would be a tax advantage in doing so in March rather than April.
Of course no businessman should invest in plant just to obtain a tax advantage. The need to invest in plant needs to be there before tax planning is considered.
Capital Gain Tax Planning
An individual with a share portfolio who regularly realises gains should consider disposals to increase gains for the year to close to £10,100. Where this limit is exceeded, he should consider disposing of shares standing at a loss. It is important to remember that disposals and acquisitions of the same shares within a 30-day period are matched.
Post 5th April 2011 Planning
By and large, once 5th April has passed, there is little that can be done to reduce a liability for the 2010/11 tax year. One exception is Gift Aid. A person who makes a gift aid donation between 6th April 2011 and 31 January 2012 can carry that contribution back to the 2010/11 tax year. To do so, he must include the contributions on his 2011 tax return and file by 31st January 2012. In marginal situations, the tax saving can be high. Suppose for example an individual has a gross salary of £100,000 and a dividend of £900 net. The dividend will increase his liability by £387. If he contributed £800 net (£1,000 gross) to a charity by means of gift aid, he would eliminate this £387 liability.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Should you have any queries or wish to discuss any of the points raised, please contact Peter Edwards or Suresh Dhokia on 0161 477 6789.
Disclaimer
This document has been produced for general guidance only and does not constitute tax advice. Whilst every care has been taken in its preparation, Warr & Co will not accept liability for any loss incurred as a result of any use made of this document or its contents. We will be happy to offer specific advice to clients when requested. Should you have any queries or wish to discuss any of the points raised please contact Suresh Dhokia or Peter Edwards on 0161 477 6789.
Date of Article: 31st January 2011
