The next step

how tax relief is given for deductible expenses

[Further Information]

The calculations behind the example

[Document]

Last minute income tax planning for directors

Two-step plan

Because of tax and NI increases which happen in April there’s more talk than usual about director shareholders setting a tax-efficient level of profit and income extraction for the new tax year. However, that’s only half the story. In practice it’s rare that the plans made at the start of a tax year will remain ideal by the time it ends. That means now is the time to consider if the planning you did a year ago needs tweaking, for example, by taking more income from your company or making tax-deductible payments.

Using your tax-free allowance

The first step is to check that you’ve drawn enough income from your company so that together with any other income you’ve received in this tax year, e.g. rental income, bank interest, etc., it at least equals to your personal tax-free allowance of £12,570 for 2021/22. If necessary, draw more income from your company.

Tip. Take salary up to the NI primary earnings threshold of £9,564 (£9,880 per annum from 6 April and then £12,570 from 6 July 2022). Beyond that, generally, dividends are more tax and NI efficient, followed by benefits in kind.

Using your rate bands

Next, aim to use all of your basic rate band; in England and Wales that’s £37,700 for 2021/22. As already mentioned, taking dividends is the most tax efficient for this. The tax rate is 7.5% (but 8.75% for 2022/23) until your total income exceeds the basic rate band, compared to 20% for salary or other income.

Tip. Your tax-free allowances and basic rate band can be greater than the figures stated if you pay tax-deductible expenses, e.g. interest on qualifying loans, pension contributions and gift aid payments (see The next step ). These increase the amount of income you can receive tax free or how much of it is taxable at the basic rate of tax.

Example. Mary is the sole director shareholder of Acom Ltd. Her income from the company for the whole of 2021/22 is £60,000. However, she’s entitled to tax relief for qualifying loan interest of £5,500 and job-related expenses (not reimbursed to her by Acom) of £500. Her taxable income is therefore £54,000. From this Mary can deduct her personal allowance (£12,570). Of the remaining £41,430 the amount taxable at the higher rate is £3,730 and the rest at the basic rate. Mary can avoid the higher rate tax by paying a pension contribution of the same amount on or before 5 April 2022, saving her up to £1,492 in tax (see The next step ).

Tip. Pension contributions reduce your tax bill by up to 40p in the pound if your income means you’ll pay tax at the higher rate. The same applies for gift aid payments. If overall you don’t want to spend more on pensions or gift aid, you can pay some or all of the amounts you would pay next tax year in the current one instead and so improve tax efficiency without additional cost.

Tip. If you’re in the position that you want more cash now but taking more income from your company would be taxable at higher rates, consider borrowing the cash from your company this tax year and repaying it next. This gives you another bite at the cherry to keep your income tax at the basic rate only.

For more information on tax-deductible expenses and the calculations behind the example, visit https://www.tips-and-advice.co.uk , Download Zone, year 22, issue 12.