Over the next few weeks, we are going to look at a Tax Strategy for your business. We will start with a sole trader/partnership and look at a limited company next week. The reason for this is to give you some ideas in this space. You want your business to be as lean and efficient as possible. The same principle will apply to your taxes. You want to ensure that you are not paying more than you should. And your dealings with Revenue are not difficult and time-consuming. Some of the areas we will touch on are
- Understanding Tax Bands and credits
- Capital Allowances
- Employing Spouse/Civil Partner & Others
Understanding Tax Bands and Credits
Are you married or in a civil partnership? If so, you and your spouse/civil partner can earn up to €70,600 at the lower tax rate of 20%. The most the higher income earning spouse/civil partner can earn at the lower rate is €44,300. This leaves the other spouse/civil partner with a lower rate band of up to €26,300. The lower rate band for a single person is €35,300. For you, you must know when you hit the higher tax rate of 40%. If your spouse/civil partner is working and has a good income, then he/she may have €35,300 or €44,300 of the lower rate band.
This will leave you with either €35,300 or €26,300 at the lower rate. Any profits you earn above that will be at 40%. This is before PRSI and USC. PRSI is 4% and USC rates are higher on higher profits. Once you enter the 40% Tax bracket you will be edging closer to 50%. This can go up to 52% with 8% USC and even as far as 55% for those with profits greater than €100,000, the USC rate climbs to 11%. Info on Tax rates and credits see here
Paul O’Donovan, aged 38, runs a successful retail business. He sells outdoor dining equipment, fans, heaters, and coffee machines. Prepares his accounts to the 31st of December and his profit was €150,000 to the end of December 2020. He is married with 4 children and his wife Sinead is at home and not in employment. Paul and Sinead are jointly assessed, and their tax liability is as follows
|Less Tax Credits|
|Add PRSI €150000||4%||€6000|
|Total Tax liability||€60946|
Paul’s accountant Roger wasn’t looking forward to telling him the numbers over Zoom. Paul hadn’t paid any preliminary tax for 2020.
If you have assets or equipment that you use in your business, you can get capital allowances on these. These are assets that help you generate profit. You don’t get a deduction for the cost in your Profit and Loss account. Let’s assume Paul had the following assets in his business
|2 Vans cost||€50000|
|Computer equipment cost||€10000|
|Office furniture cost||€5000|
Paul can get Capital allowances at 12.5% per annum over 8 years. This would reduce his taxable profits by €12500 in 2020. His taxable profit would be €137,500 resulting in a tax saving of €6875 [€12500 x 55%]
To get Capital allowances you must own the asset and it must be in use in your trade before the end of the accounting year. You own assets that you buy with a loan or on Hire Purchase and can claim capital allowances on these. The interest expense will go against your profits throughout the loan or HP. If you lease the asset, then you don’t own it and can’t claim capital allowances on it. But you can get a deduction for the lease payments.
Also, it is possible to get 100% Capital allowances on energy-efficient equipment. This means that you can get the full cost of this type of equipment written off in the year you buy it and not 8 years. For more info on this see here
Vat bores people and it even bores me, and I like tax. Hang in there if you can! This side of the business must be looked after very well. You need to make sure you claim all the Vat you can but don’t claim what you are not entitled to. You can’t claim Vat on petrol or entertainment but can claim on equipment, diesel, and other inputs.
Understanding the different Vat rates for the products or services that you sell is key. You will need to have a good handle on the rates and registration thresholds. Areas that can be tricky are
- Vat on property
- Trade-in of vehicles or equipment
- Postponed accounting for Vat
- EU and non-EU purchases
- Sales of Equipment and services inside and outside the EU
- Sales Business to Business or business to consumer
- Vat return of trading details
Good systems and bookkeeping will help with the Vat process and will help limit errors.
Employing Spouse/Civil Partner & Others
Let’s assume that Paul’s wife Sinead does some work in the business. She looks after the sales invoices, ordering supplies and credit control. She spends 20 hours per week doing these jobs. If Paul was to hire someone else to do this work, he thinks a fair rate of pay would be €20 per hour. He decides to put Sinead on the payroll at €400 per week which is €20800 per annum. This makes sense for many reasons
- Paul will save tax at 55% which is a tax saving of €11440
- Sinead will only pay tax at 20% as she can earn up to €26300 at the lower rate
- They will lose the Home carer credit of €1600 as Sinead now has an income but gain the Earned Income credit of €1650
- There will be no employer’s PRSI as it is the employment of a spouse
- Sinead won’t pay PRSI but will pay lower rates of USC
The key points when it comes to employing family members are
- They get paid for genuine hours worked
- Pay has to leave the business bank account and go into the family member’s account
- The pay rate has to be suitable for the type of work performed. The question to ask yourself is what would you pay to a non-family member for the same work?
For more information on employing family members see here
The success of your business will often depend on the quality of your staff. Understand the rates at which you go into higher employment taxes such as PRSI. Pay rises, bonuses, and commissions will be subject to tax, PRSI, and USC. If your employee is already in the higher tax bracket will a small pay increase or bonus do much for them? Other benefits can be considered and have different tax implications. These can include
- Company pension
- Medical insurance
- Staff trips
- Company car or van
- Share schemes
You don’t have to do Vat returns at night after a long day at work. What could be more horrific than the thought of it! But some people do this, and some do it well and others not so good at all. Realise what you are good at and get others to help in the areas where you are weak. Remember you will need to surround yourself with a good team. They are not only staff but accountants, tax advisers, bankers, and solicitors too.
Investing in good systems and processes will pay off for you. the business should become less reliant on you. This will give you time to think about the future and put the right team and structures in place to continue to grow. Great admin and bookkeeping are vital. The advantages of this are many
- Everything is filed and paid on time with Revenue. You are not paying surcharges, interest, or penalties
- You are not paying more than you should and have little or no interaction with Revenue. Your accountant takes care of all that
- You have tax clearance, so you get Vat refunds on time, tax refunds are not held up and you are on the 0% rate for RCT
- You don’t spend time worrying about this or dealing with Revenue. So, you have more time to concentrate on what you are good at
- You know your numbers during the year and not 9 months after the year-end. You can make decisions based on up to date numbers, not historic ones
- Get more insights into your business such as profitable and loss-making customers. You will know who to work with and who not to
- Eliminates paper. This is expensive to print and store and information is easy to access when you need it. Not in a shed that takes two days to get!
- Your end-of-year accounts and tax return are easier if your accountant is doing the bookkeeping too. They have all the info.
Paul knew he was doing well during the year but didn’t have any idea of how well. If he knew he could have made decisions earlier. Like setting up a limited company from the start of 2021
See our blog here on bookkeeping is an investment
Pension – Pay yourself first
I heard this from an advisor on the radio one day. Putting money into a pension is paying yourself first. It struck me as making so much sense. You are saving for the future and getting tax relief of up to 40% on the payments. Plus, the pension rolls up tax-free. You only pay tax when you draw down the pension. But you can get 25% tax-free so in my mind they are a no-brainer.
The magical number is a pension pot of €800000. I know that is an awful lot of money but if you invest early and well then it is possible to achieve. Why that number? It’s the ideal figure to earn the most tax-free money you can get which is €200000. After taking the tax-free lump sum you have €600000 left. If you take 5% of that each year that will be a pension of €30000. If you get the state pension on top of that of €13000 that is a total income of €43000. You will only pay tax on all or most of that income at 20% with lower USC rates and no PRSI once you hit 66.
For 2020 Paul can pay 20% of €115000 into a pension to reduce his tax liability. This is €23000. He would get tax relief on this at 40% so the tax saving is €9200. The tax relief is brilliant, but the gravy is that he has put away €23000 into a pension. This will grow into a much larger amount over the next 30 years until he draws it down. Luckily for Paul, he can make this pension contribution before the 31st of October 2021. Once he does this and claims it on his return, he will get a tax deduction for 2020. As his tax liability for 2020 is lower, his preliminary tax payment for 2021 will be lower too. See here for tax relief on pension contributions
Some businesses such as doctors, dentists, and barristers can only be sole traders. Very often their top tax rate is 55%. Paul will have the option of transferring his business to a company. That should lead to lower taxes. Lower taxes mean more money to invest for him through salary, bonus, and pension. Lower taxes can also mean more money to invest in the business be it staff, equipment, or expansion. Post-year end Paul can only save tax through a pension payment. If Sinead was an employee during the year that would have reduced his taxes.
Meeting Roger 6 months after the year-end to tell him the bad news won’t be good for him or Roger. He will be halfway into the new year and have the same tax problems in 2021 as he had in 2020. Investing in his bookkeeping will pay dividends. It will empower him to have his key numbers and information to grow the business. Paying into a pension will save him tax and provide a more comfortable retirement for him and Sinead.
Interested in getting the right partner for your business? Call Deirdre on 051396703 or start here. Tell us about you and your business to see if we can help.