Tax-Saving Secrets: How You Can Reduce Your Tax Bill
summary
- Consider incorporating your business for lower taxes and dividend benefits.
- Claim all allowable expenses, such as use of home allowance to maximise deductions.
- Pay into pension schemes and donate to charities to reduce income tax liability.
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How You Can Reduce Your Tax Bill: A Guide for side hustlers
You’ve finally pulled it off — a side hustle that allows you to earn steady additional income. Then comes along the annual tax return, swooping in to take away chunks of your hard-earned money. Don’t fret; there are acceptable and legal ways you can lower or eliminate these tax payments. Below, we’ve shared a handy guide on how you can reduce your tax bill. Let’s dive in!
| Tax Saving Strategy | How? |
|---|---|
| Incorporating Your Business | Incorporate to benefit from lower corporation tax rates compared to personal income tax. |
| Claiming Allowable Expenses | Claim all business-related expenses to reduce taxable profit, including office costs and travel. |
| Utilising Pension Schemes | Make pension contributions to lower taxable income and receive tax relief based on your marginal rate. |
| Selecting the Right VAT Scheme | Choose a VAT scheme that aligns with your business size and nature for maximum savings. |
| Capital Allowance on Assets | Claim deductions for large asset purchases, reducing taxable profits over time. |
| Charitable Donations | Lower taxable income by deducting value of charitable donations from earnings. |
| Leveraging Tax Allowances | Take advantage of tax exemptions and reliefs like marriage and trading allowances to reduce tax. |
| Utilising Losses | Offset current profits with losses from previous years to reduce overall taxable income. |
Understanding the Types of Taxes You Need To Pay
When you register for self-assessment with HMRC, you probably already have an idea of which types of taxes you’ll need to pay. However, there are different types of tax forms you’ll need to fill out. These vary depending on your business structure. For those operating side hustles and small businesses, the two common structures are limited companies and sole traders.
For sole traders, your obligations are income tax and National Insurance. There is no legal difference between you and your business, so you will need to pay taxes on all your profits. You must also register for VAT once your turnover reaches £85,000 per tax year.
To reduce your taxes, you can incorporate your business, turning it into a limited company. This is the second business structure, and it’s more beneficial for those who are already established or familiar with their trade.
When you turn your business into a limited company, you’ll be classed as a director, and once you are, you can take some of your earnings as dividends. The first £1,000 of these earnings is tax-free. In addition, you can enjoy lower tax rates as a limited company in certain scenarios. Take note that you will need to pay Corporation Tax, paid separately from your personal income tax.
Before you restructure your business, we recommend consulting a
Chartered Accountant
and understanding what effects this change might have on you and your business.
Take Advantage of Allowable Expenses
Now that you have an idea of what types of tax your business needs to pay, let’s discuss ways you can legally reduce your dues. The first step to reducing taxes is to claim all your allowable expenses.
What are allowable expenses?
When you own a business, you pay tax on your profits, not your total revenue. Profits only come after you’ve deducted your expenses from your revenue. Thankfully, you can claim business expenses to save you tax. These expenses can provide enormous tax relief if you include the allowable ones.
The following are generally acceptable, but we recommend consulting with an accountant to be sure, as knowing what you are eligible to claim is one of their prime areas of expertise.
- Expenses for business premises, such as rent and utility
- Claim the use of your home as an office
- Office and stationery costs, including IT, phone services, and printing
- Legal and financial expenses such as professional consulting and accounting services
- Travel costs, but not including personal travel expenses
- Inventory, stock, and raw material expenses
- Marketing and advertising
- Staff costs, including uniforms
- Vehicles and fleet
When claiming these business expenses, make sure to complete the correct boxes on the tax return and include the right amounts before submission. HMRC won’t typically ask for evidence for these expenses, but they may request proof of the expenditure if they find inaccuracies or questionable inclusions. Having accurate records will give you peace of mind and help you avoid any trouble with the tax man.
Tax Relief Through Business Assets
Your business assets are any equipment, items, or even cash that you own or lease to continue your operations. These assets do more than just help your business function — business assets can also help you reduce your tax liability in a few ways.
Capital Allowances
When you first start your business (and even as years go by) you may need to purchase a capital asset. Business assets are the significant items you need to purchase in order to start and continue operations, and they usually cost more than your daily running costs. For example, those who design clothes can consider sewing machines or large printers as capital assets.
You can claim capital allowances on these assets, letting you deduct the value of the asset from your profits. It’s similar to claiming business expenses — capital assets are technically business expenses, after all.
Disposing of personal Assets
The term “dispose” doesn’t mean throwing away your assets — it refers to the act of selling, swapping, or trading a capital asset in exchange for compensation. The profit is called a capital gain, and it’s taxable and subject to capital gains tax. Thankfully, you can get tax relief through the annual exempt amount.
Unfortunately, limited companies cannot enjoy this benefit as they are not qualified for the annual exempt amount.
Which VAT Scheme Are You Using?
As we mentioned, you need to register for VAT as soon as you reach the £85,000 sales income threshold. VAT is ultimately paid for by your customers, and you’re just paying what they owe on to HMRC. Still, there are ways to reduce your VAT liability.
Review the VAT Flat Rate Scheme (FRS). Through the FRS, you pay a flat rate across to HMRC, instead of trying to figure out VAT you can reclaim on your purchases.
You can also register voluntarily for VAT before you reach the VAT threshold. This can be beneficial as you can then reclaim VAT on your business purchases. Just remember you will need to charge your customers VAT.
Donate to Charity for Tax Relief
Donating to charity doesn’t just allow you to help the needy, but you could also earn tax benefits. There are specific ways charitable donations reduce tax dues for each structure.
For Sole Traders
When submitting your self-assessment tax return, you can include the donation you made under gift aid relief. For higher rate tax payers this can increase your basic rate threshold, saving you higher rate tax.
For Limited Companies
Donating to charity allows you to claim corporation tax relief on the donation.
Leverage Tax Allowances
Tax allowances are valuable tools for reducing your taxable income, acting as deductions from your gross earnings. However, it's important to note that not all tax allowances are applied automatically. Some require specific actions or claims to be utilised effectively. Many individuals are not fully aware of these allowances or may find it challenging to understand how to apply them. Seeking guidance from a Chartered Accountant is advisable to navigate these options and maximise your tax savings.
Below, we delve into a couple of key tax allowances:
Marriage Allowance
Are you aware that transferring a portion of your personal allowance to your spouse or civil partner can lower your income tax? This is achievable through the Marriage Allowance. It enables you to transfer up to £1,260 of your Personal Allowance to your spouse or civil partner, provided your income is lower than theirs and both of you fall under the income threshold for higher rate tax.
Trading Allowance
For sole traders and side hustlers, the Trading Allowance offers significant benefits. If your annual trading income is less than £1,000, you are exempt from paying tax on it. This exemption simplifies tax affairs for small-scale traders. However, once your income exceeds this threshold, you're required to register for self-assessment with HMRC and declare your earnings.
Trading Loss To Reduce Income Tax
There is a method to utilise a capital or trading loss from a previous year to lower your income tax. Imagine that you incurred a loss in profits last year. In the UK, you can 'carry back' this loss to offset against profits made in that same year. When preparing your tax return, apply this loss to decrease the taxable income for that year. If you have already paid tax on this income, you may be eligible to claim a refund from HMRC.
pay into a Pension Scheme
A pension scheme not only helps secure your future after retirement, but this practice can also help you enjoy some tax relief. You can claim deductions based on your current tax rate. If you’re within the 20% basic rate, your pension provider will automatically claim the tax relief on your contribution. Even those in Scotland, who start at 19%, are entitled to this benefit. People who pay above the 20% basic rate can claim additional tax relief, which would be the difference between the higher tax rate of 40%+ and the basic rate.
The above applies to both sole traders and directors of limited companies.
Additionally, if you trade as a limited company, you can make it so that your business pays your pension. This practice helps you reduce your corporation tax since you’re essentially paying the pension of an employee — the employee being you (the director).
Keeping Your Money in a Tax-Efficient Place
Many budding entrepreneurs and first-time business owners keep their money in business bank accounts. While this method is the easiest and safest choice, it may not be the most efficient in terms of tax savings. The interest you earn is still taxed. Thankfully, there are ways to earn dividends tax-free.
As a sole-trader, you can put your money into individual savings accounts (ISAs), which let you save tax-free. Joining venture capital trusts and Seed Enterprise Investment Schemes (SEIS) also allows you to claim tax relief as an incentive for the investments you make. Talk to your accountant to learn more about the other investment programmes available and determine if you’re qualified to join.
Incorporation involves transforming your business into a limited company, which can offer several tax advantages. When you incorporate, your business becomes a separate legal entity, leading to different tax treatment compared to being a sole trader.
The Potential Tax Benefits of Incorporation
Lower Corporation Tax Rates
One of the primary advantages of incorporation is the potential for lower tax rates. Limited companies in the UK are subject to Corporation Tax, which is often lower than the higher personal income tax rates that affect sole traders.
Dividend Allowance
As a director of a limited company, you have the option to take a portion of your earnings as dividends, which can be tax-efficient. The first £1,000 in dividends is tax-free, and dividend tax rates are generally lower than income tax rates. This strategy can be particularly beneficial for those in higher income tax brackets.
Pension Contributions
Limited companies can make pension contributions, which are considered allowable business expenses. These contributions can reduce the overall Corporation Tax liability, offering a dual benefit of tax savings and retirement planning.
Considerations Before Incorporating
Compliance and Administration
Incorporation brings additional responsibilities, like filing annual accounts and abiding by corporate governance rules. This increased administrative burden requires diligent record-keeping and possibly additional professional support.
Director's Responsibilities
As a director, you'll have legal obligations that go beyond tax matters. This includes ensuring the company complies with all laws and regulations applicable to its operations.
Profit Extraction Methods
Extracting profits from a limited company can be more complex than withdrawing money from a sole trader business. You'll need to plan how to pay yourself - through salary, dividends, or a combination of both - while considering the tax implications of each method.
Following Best Bookkeeping and Accounting Practices
All the tips we shared above build off from a foundation of good bookkeeping and accounting practices. Using accounting software such as Xero or QuickBooks can give you accurate, well-organised records and help you keep a close eye on your finances. With an in-depth understanding of how your business is doing, you can make better-informed decisions and ensure accurate filing once tax season comes.
When you have organised records, it becomes much easier to find expenses for claiming, how near you are to the next tax rate, and which allowances you may be qualified for. Work with your accountant because they’re the ones who will make sense of the numbers and provide advice that helps reduce your tax obligations.
FAQs
Final Thoughts on Reducing Your Tax Bill
As a business owner, you’re legally obligated to pay taxes — whether you’re a sole trader or the owner of a limited company. The bills may be steep, but thankfully, there are ways to reduce your taxes. From claiming business expenses to joining a pension scheme, from choosing the right VAT scheme to leveraging tax allowances, you can try various methods to lower income and corporation tax payments, helping you keep more of your profits without breaking any laws. Follow the guide we shared above while consulting with a qualified accountant.
BEFORE YOU GO...
As we've explored ways to trim your tax bill, remember that understanding the broader tax landscape is key, especially for side hustlers. Our next article, "Side Hustles and Your Tax Obligations," offers a more comprehensive guide on the tax intricacies for side hustlers. It's essential to stay informed and ahead in your tax planning journey. So, don't miss out on this vital read – it's the perfect complement to the strategies we've discussed here and a step towards smarter tax management for your side hustle. Stay informed and ensure your financial health remains robust. Join us in our next exploration of the tax world!
sidehustles.co.uk one-minute podcast
🎧 Listen Now: Sidehustles.co.uk One-Minute Podcast
Tax-Saving Secrets: How You Can Reduce Your Tax Bill.
Welcome to the Sidehustles.co.uk One Minute Podcast. In the next 60 seconds, we're sharing a real-world insight from our network of seasoned side hustlers. This quick tip is designed to offer you practical advice that you can apply immediately in your side hustle journey.
Today we're exploring Tax-Saving Secrets and How You Can Reduce Your Tax Bill. One key strategy for small business owners to reduce their tax bill is to thoroughly utilise allowable expenses. This means claiming every legitimate business expense, from office supplies to travel costs. Many business owners don't realise the extent of what they can claim. For instance, if you work from home, a portion of your utility bills could be deductible. Every expense you claim reduces your taxable profit, which directly lowers your tax bill. Remember, it's not just about earning more, it's about keeping more of what you earn by being tax-smart. So, take a moment to review your expenses and ensure you're making the most of these deductions. It's a simple yet effective way to enhance your business's financial health.
That's your one-minute real-world insight. Stay tuned for more!
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