In the UK, Income Tax is a significant consideration for individuals and businesses.
Understanding how it works and employing legal strategies to minimise tax liabilities can significantly impact one’s financial health.
This blog will explore the UK’s “small, medium, and large” Income Tax thresholds (20%, 40%, and 45%) and discuss legal methods to gear your income towards a lower tax bracket, focusing on the utilisation of dividends and other means.
UK Income Tax rate bands
Here are the current UK Income Tax rate bands:
- Personal allowance (Up to £12,570) = 0 per cent
- Basic rate (£12,571 to £50,270) = 20 per cent
- Higher rate (£50,271 to £125,140) = 40 per cent
- Additional rate (over £125,140) = 45 per cent
Strategies for tax efficiency
Several tax efficiency strategies exist for mitigating your tax liabilities and improving the overall financial health of your personal income.
It is important to note that managing these incorrectly could mean you are breaching the law and committing tax fraud, so it is always advisable to consult a qualified accountant before proceeding.
Utilising dividends
Dividends received from shares are taxed at lower rates compared to salary or self-employed income.
This can be an effective way to receive income from a business you own or part-own.
The first £1,000 of your dividend income in the April-to-April 2023/24 tax year is tax-free, regardless of your other income – any dividends above this are taxable.
This will be reduced to £500 next year, however, so watch out for increased tax liabilities and manage these accordingly.
The current rates, based on your Income Tax bracket, are:
- Basic rate = 8.75 per cent
- Higher rate = 33.75 per cent
- Additional rate = 39.35 per cent
Business owners can choose to take a combination of salary and dividends, keeping the salary low enough to minimise Income Tax and National Insurance Contributions while taking the rest as dividends.
Business sales and getting the timing right
When considering the sale of a business, small business owners should focus on maximising tax efficiency.
A well-planned approach can significantly reduce the Income Tax liabilities arising from the sale.
This involves strategically timing the sale to align with favourable tax periods and utilising available reliefs, such as Entrepreneurs’ Relief (now referred to as Business Asset Disposal Relief), which can offer substantial reductions in Capital Gains Tax.
Additionally, reinvesting the proceeds into tax-efficient investments or pension schemes can further optimise the tax position.
Talking to your accountant early in the process is crucial to ensure all potential benefits are fully explored and utilised.
Pension contributions
Pension contributions are a tax-efficient way to reduce your taxable income.
Contributions to your pension can be made from pre-tax income, which lowers your overall taxable income.
There is an annual and yearly allowance on private pensions which means you can contribute £60,000 per year or £1.07 million over your lifetime tax free.
ISA investments
Utilising Individual Savings Accounts (ISAs) can be a great way to earn interest or returns on investments without any tax liability.
Currently, you can place £20,000 per year into an ISA and the interest you receive is tax free.
This allowance is split between your stocks and shares ISA and your savings ISA, but the amount must not exceed £20,000.
For example, you could place £20,000 into one and £0 in another, split the £20,000 into two pots of £10,000 or contribute however much you like into either, so long as it adds up to £20,000.
Capital Gains Tax allowance
Everyone in the UK has an annual Capital Gains Tax (CGT) allowance.
Selling assets like shares or property up to this allowance can be a tax-efficient way to realise gains.
When selling assets, the CGT allowance is currently £6,000 but will be reduced to £3,000 in the April-to-April 2024/25 tax year.
Any profit you make above the allowance will be taxed depending on your personal Income Tax level.
There are other factors at work here, however, so it is important to speak to your accountant and find out exactly how much your CGT rate could be.
The deadline for CGT payments, after the sale of a property, is 60 days after completion.
Inheritance Tax planning
Inheritance Tax planning, including gifting and setting up trusts, can be used to manage how your wealth is passed on and can help in reducing the Inheritance Tax burden.
By gifting your assets, you can reduce your estate below the Inheritance Tax threshold – currently at £325,000.
However, it is important to remember that CGT might apply to gifts, and you should consult with an experienced accountant who can help you navigate these regulations when gifting your wealth.
An accountant can also help you set up trusts, both to alleviate your IHT liabilities and secure a solid financial basis for your loved ones in the future.
How an accountant can help
In terms of your personal finances, an accountant can provide tailored advice based on your specific financial situation, helping you understand which tax bands you fall into and how to make the most of your allowances and deductions.
They can also advise on pension contributions and investment strategies that align with your long-term financial goals whilst remaining tax efficient and compliant.
Accountants can also suggest the most tax-efficient structure for your business, whether it’s operating as a sole trader, partnership, or limited company.
They can also assist in planning a dividend strategy that maximises the benefit of lower tax rates on dividends and decreases the amount of tax you pay on your income.
On top of this, a qualified accountant can ensure compliance with HM Revenue & Customs (HMRC).
They can help file accurate tax returns and deal with any inquiries from HMRC too.
In summary, with strategic planning and the right advice, it is possible to manage your personal and business finances in a tax-efficient manner.
Employing legal strategies such as using dividends, pension contributions, and ISA investments can help you stay within a lower tax bracket.
An experienced accountant plays a crucial role in this process, offering tailored advice and ensuring compliance with the latest tax laws.
By staying informed and seeking professional guidance, you can maximise your income and minimise your tax liabilities.
If you’d like to discuss tax planning strategies with an expert, please get in touch with our team.