Congratulations on becoming an equity partner! We need to talk about Tax
When you join a partnership, you cease to be an employee and are classed as self-employed. Here are eight short points to help you understand how you are now taxed and some tips to help you benefit from your new status.
Your income tax is no longer collected by your employer through the PAYE scheme. Instead, you must complete a tax return each year, declaring your share of the partnership’s taxable profit and the tax you owe on this profit and any other income you receive.
The partnership’s taxable profit is different from the accounting profit because some expenses in the accounts are disallowed for tax purposes. This includes depreciation, client entertaining and any personal expenses paid by the partnership, such as motor expenses.
Instead of receiving a salary, you are likely to have arranged a monthly payment to your bank account. This is treated simply as an advance of your profit share and is not reported on your tax return. The main distinction here is that you are taxed on the whole of your profit share regardless of whether you have received all of it in cash or left a part in the business to fund working capital or future growth. You will also need to remember to save for your tax bill! if your firm is not retaining some of your profit share in a separate tax reserve.
Other opportunities to reduce your tax bill
Any contributions to a personal pension plan will attract relief at your highest rate. In 2018/19 the higher rates are 40% and 45%, but if your income falls within £100,000 and £123,700 your marginal rate is 60% with the loss of your personal allowance.
For example, suppose your income is £120,000 and you decide to make a gross pension contribution of £20,000. You will pay a net contribution of £16,000 to your pension fund and your fund receives the other £4,000 directly from HMRC. You will receive further tax relief of £8,000 via your self-assessment tax return. So your pension fund increases by £20,000 at a total net cost to you of £8,000.
Any gifts to registered charities will also reduce your tax liability by extending your basic rate band. For example, if you donate £800 on your tax return this is grossed up to £1,000 and your basic rate band is extended by this amount. If you are a higher rate taxpayer this will reduce your tax payable by at least £200.
All of the above is a brief overview of some of the main remuneration issues that you need to be aware of when becoming a self-employed partner for the first time. We would encourage you to speak to an accountant or tax adviser to find out more.
Hilary Evans, Hazlewoods LLP