In the last few weeks, we spoke about the problems you may be having in your business. The problems ranged from paying too much tax to not being in control of your numbers Read here
Last week we looked at some solutions to those problems. We looked at how a company could be the answer to some of those problems Read here
This week we had a few very interesting conversations about a company structure with existing and potential clients. One of the key elements of going into a company is tax-efficiency. We are going to take a closer look at that in this blog.
I know you hear tax and fall asleep but let’s change around the way to look at this. If someone told you they knew a way to add €1000 per month to your wealth would this interest you? If you could use that money to buy your dream home or go on that bucket-list holiday maybe it would!
What I hate about self-employment
If you ask any self-employed person what is their least favourite time of the year and why. I bet the vast majority would say the two weeks from the end of October to the middle of November. This is smack bang in the middle of pay and file tax time in Ireland. Not only is the weather crap but you have to pay your life savings to Revenue. You have to file your tax return and pay whatever balance is due for the previous tax year. On top of that, you have to make a tax payment on account for the current tax year called preliminary tax. This is up to 100% of your previous year’s liability.
Paul, a website designer, has a tax bill of€40,000 for 2019. He made a preliminary tax payment of €30,000 to Revenue in early November 2019. To find out more about the pay and file system Read here
|Income Tax Liability||2019||€40,000|
|Preliminary Tax paid||2019||€30,000|
|Total Due||2019 & 2020||€50,000|
When you tell Paul this news he is thinking of the many ways he wants to murder you. Then his mind may move to source the funds to pay what he owes.
Often the accountants that are breaking this news to Paul and other clients are in the same boat. They are scraping the funds together to pay their tax bills.
In an ideal world, Paul and others would have that tax set-aside. However, it’s not an ideal world and there are always plenty of homes for available funds. When there are mortgages and holidays to pay, children to look after, and many other bills, tax may not be a priority.
Would a company make November more bearable?
The short answer is yes. A company structure will get rid of that large annual tax payment. Your tax bill arises during the company accounting period. And the amount you pay during the year can be lower.
As an owner-director of a company, you would still have to file an Income Tax return. But as you are now on a salary from your company the tax was already deducted at source.
As the company is a separate legal entity to you the company pays tax at 12.5% on its trading profits. You, as the owner-director will take a salary from the company and will pay PAYE on that salary. The amount of tax you pay on your salary will depend on your circumstances and the salary level.
Let’s assume Julie takes a salary of €60,000, she is married and her spouse is earning €20,000. This tax is as follows;
|First €44,300||Taxed at 20%||€8,860|
|Next €15,700||Taxed at 40%||€6,280|
|Less Tax credits||Married & Earned Income||€4,800|
|Net Tax liability||€10,340|
|Add PRSI & USC||[approx]||€4,400|
|Total Tax bill||€14,740|
For more info on Tax rate bands and tax credits Read here
Julie’s net salary is approx. €3,750 per month. The company pays the PAYE throughout the year and deducts that from Julie’s salary. Julie doesn’t have to worry about coming up with €15,000 in November to pay her 2019 tax bill. Nor does she have to worry about paying another €15,000 for the current tax year. Julie will have a happier November.
Are we comparing apples and oranges?
Paul had a tax bill of €40,000 and Julie had a tax bill of under €15,000 so Paul must have had a lot higher income. This would be correct. Let’s assume that Paul, the sole-trader, had a profit of €110,000, and Julie’s company had a profit of €110,000. Julie didn’t take a salary of €110,000 but €60,000. In the company situation, after deducting Julie’s salary, the net profit in the company is €50,000. As this is the trading profit the company pays tax on that profit at 12.5%. This is the company’s corporation tax liability which comes to €6,250. The combined tax liabilities of the company and the taxes on Julies salary is €21,250, whereas Paul is paying €40,000
If Julies needs a higher salary the company will be less tax-efficient, but still more tax-efficient than Paul. If Julie takes all the money out in salary then the company will end up paying the same tax as Paul. So a company structure may not be suitable. The only saving grace for Julie is that the tax is gone and she would still have a more enjoyable November.
A Company is your flexible friend
The key point in the above 2 situations is that the company gives Julie way more flexibility than Paul. Paul has no choice but to pay his taxes based on the profits of the business. In her company Julie has flexibility. She has many options which can benefit her and the company such as;
1. Flexibility around salary payments – she can set her salary and take more or less
2. If she needs more money she can take additonal salary, bonus or dividends – take it when it’s there
3. Set her salary to maximise lower rate bands in the early years of growing the company
4. Receive tax-free expense payments for travel & subsistence – this can supplement net salary
5. Repay money owing to her from her Director’s current account over time or in lump-sums
Plus no November pain!
Director’s Current Account
A sole trader or a partner in a partnership may want to transfer their business into a company. The value of the assets they transfer, more than the liabilities, is money that is due back to the transferor. This is the Director’s current account. Say you transfer cash of €30,000, debtors of €40,000 and loans of €20,000 the excess of assets over liabilities is €50,000. This money is due to you from the company tax-free when funds are available and when it is wise to do so.
In Julie’s case above she could use this asset in a tax-efficient manner. She could reduce her salary to €44,300 and save PAYE at 40%. The shortfall in her salary can come from the Director’s current account to bring her net salary back to €3,750 net.
This money could also be useful in the early stages of the business. It could clear personal tax liabilities or clear other personal debts, such as loans or credit cards. So the net take-home salary wouldn’t go to fund these outgoings.
We will look at this in greater detail in future blogs. There can be other tax planning tips when going into a company from an established business.
The key message we are trying to get across is the tax benefit that a company has and the flexibility that it allows. The higher the profits the more sense it makes from a tax perspective. This is very obvious if you don’t need to take all the profits from the company in salary. You as the company owner can set your salary and what you need will depend on your circumstances. If your spouse or partner is working then you may not need a very high salary. So more of the profits can stay in the company and enjoy a low corporate tax rate.
If you would like to explore your options further please contact us. to arrange a call with Colin, Ger or Darragh. Alternatively, call Deirdre on 051396703 to book an appointment