While no one likes to pay tax, making sure you have enough set aside to meet your obligations is important, particularly if you run a small business and use self-assessment.
There is no ideal percentage that all small business owners should set aside for taxes, as the amount will vary depending on a number of factors, including the type of business, the industry and the owner’s personal income.
A solid rule of thumb, however, is to set aside 30% of all income after deductions.
SMEs that include sole traders and individuals in partnerships mostly operate using self-assessment which means they fill in one return at the same time each year. Limited companies, on the other hand, are taxed differently from their owners, so the amount of money that needs to be set aside can be a lot different.
Why do you have to set aside money to pay taxes?
Small businesses tend to have tighter budgets and less to spend on areas such as growth and marketing. The problem with completing a self-assessment tax return is that it leaves you with one large bill rather than the monthly tax payments you have as an employee.
A bill for income tax once the financial year finishes will also include national insurance contributions. Not paying on time because funds are tight can also mean that you get fined by the HMRC.
What is the best way to save for small business taxes?
Making small changes to the way you run your business can mean that you don’t have to worry about your finances when it comes to paying your tax.
- Set up a separate savings account. This will help you to keep your savings separate from your business income, and it will make it easier to track your spending.
- Make regular payments into the account. This will help to ensure that you have a steady stream of income coming into the account, and it will make it easier to reach your savings goals.
- Automate the process. You can automate the process by setting up a recurring transfer from your normal account to your savings account, either weekly or monthly. This will help you to save money without even thinking about it.
- Set a goal. Having a specific goal in mind will help you to stay motivated and on track. For example, you could set a goal of saving up for a new piece of equipment, a marketing campaign, or an emergency fund.
- Don’t touch the money. Once you have put money into your savings account, resist the temptation to dip into it for other expenses. The money in your savings account should be for emergencies only.
Tax planning tips for small business owners
Tax planning is just as important for sole traders and small business owners as it is for larger companies.
If you have a lower income
The 30% rule for income tax comes from the fact that the lower rate of tax is 20% and on top of that you pay around 9% for class 2 and 4 national insurance contributions. You should also take into account the income tax threshold – you can currently earn £12,750 before you pay it.
If you’re income is, for example, only £15,000 a year, then you will need to pay tax of 20% on just £2,250 which should be manageable. Essentially, the higher your earnings, the more sensible it is have money saved so that you can pay your tax bill for the year when it comes due.
It’s important to keep accurate accounts including all outgoings for your business that you use to offset your final tax payment. If you are making enough and can put some aside for tax, it makes sense if you don’t want a nasty surprise when you come to do your return.
If you have a higher income
If you earn £50,271 a year or more, then you will need to pay the higher tax rate of 40%. It can make much more sense to put money aside for tax purposes and can save a lot of issues.
It certainly should mean that you keep your business account separate from your personal one and ensure that you keep track of all incomings and outgoings.
Using accounting software can also help you monitor how much of your work is profit and what is made up of, for example, deductibles such as travel, tools, and materials.
Contact VW Taxation today
Working with an experienced accountant can help you manage your small business income better. That includes making sure that you have enough money put aside for when you do your tax return.
At VW Taxation, we partner with many small businesses in the Portsmouth area and beyond, helping them to maximise their profits, make the most of their personal allowance and deductions and reduce their overall tax burden.
Want to find out more? Contact us today.
Putting aside some of your profits to pay your income tax for the year makes perfect sense. In general, most experts suggest 30% as a suitable amount to cover these annual expenses but it can vary depending on the type of business and income.
If you want to learn more about the taxes that incur for small businesses, then check our guide all about small business taxes.