Starting your own business can be an exciting and liberating time, providing much more freedom when compared with the standard 9 to 5. However, there are aspects of self-employment which places more responsibility on the business owner, one example being taxation. As an employee, taxes are calculated and deducted prior to wages being paid. Therefore, many workers don’t give too much thought to their taxes. However, business owners are the people in charge of paying taxes, correctly and on time. Those who are new to self-employment can sometimes find this system to be daunting and complicated. With this in mind, how should beginners approach small business taxes?
One of the main taxes that small businesses will encounter is income tax. Income tax is applicable to both sole traders and partnerships. The tax itself is applied to any profits the business makes, therefore the money that’s left after all of the expenses have been deducted. In the case of a partnership, the profits will be divided between the partners and then the tax is applied.
There are different bands of income tax and currently in the UK, business owners can earn up to £12,570 in profit before they have to pay any income tax at all. There is then 20%, 40% and 45% tax bands, applied at specific profit boundaries. However, as a smaller business it’s unlikely you will have to worry about the upper bands of income tax, at least not to begin with.
Those who own a limited company do not pay income tax but instead are subject to corporation tax. This is applied to profits, after expenses and salary has been deducted but before the deduction of dividends. Currently, the main rate of corporation tax is 25% but is only applied to limited companies with profits of over £250,000. There is a small profits rate of 19% which is applied to limited companies who have made under £50,000 in profit. Those who have earned a profit amount in between these two numbers will deal with a tapered rate.
It’s common for limited company owners to utilise dividends as a way to increase tax efficiency. This is because dividends are not subject to national insurance and are therefore a cheaper way to take money out of the business, when compared with a salary.
National Insurance or NI payments are made in order to ensure specific societal benefits, ranging from pensions, unemployment benefits and of course, public services. For those who are self-employed, NI is calculated and paid via the self-assessment process. If you have profits of £12,570 or more a year, you will have to pay both Class 2 and Class 4 NI rates.
In the case of limited companies, NI is often paid twice. The company itself is classed as an employer and will therefore have to pay NI and the company director is classed as an employee and will therefore make NI contributions from salary and bonuses.
Valued Added Tax or VAT, as the name suggests is a tax that is added to a product or service at every stage in which value is added. Whereas a standard sales tax would be placed on the eventual consumers, VAT is applied at different stages of production and therefore the cost is shared. Companies will only have to register for VAT if they have a VAT taxable turnover of £85,000 or more. However, it is possible to register even when you don’t meet this boundary and some businesses do for the potential benefits involved.
Businesses which are VAT registered will have specific responsibilities, including applying VAT to products and services, keeping records and eventually paying VAT to HMRC. The process can sometimes seem somewhat convoluted but eventually there is a balance between the VAT you are owed and the VAT you have paid.
If you’re a business that employs staff, then there are specific tax based responsibilities that you will be expected to meet. One of the main responsibilities being PAYE or Pay As You Earn, in which employers must deduct the relevant income tax and NI from their employee’s salaries. These deductions are then paid to HMRC on behalf of your employees. Of course, there’s also records which must be stored and general paperwork.
Running a small business can be complicated at the best of times but especially when it comes to taxes. Fortunately, there is so much help online for those who are struggling with this specific aspect of self-employment.
The team at Taxation Investigation have the experience and expertise to provide the ideal tax solution, whether that be services or just key advice.