Last Minute Income Tax Planning For Directors

Sarah Bradford provides some year-end tax planning tips for company directors.

The tax year 2017/18 comes to a close on 5 April 2018. As the tax year end approaches, it is a good time to take stock and review your financial position and make sure you have made the best use of 2017/18 rates and allowances. Below, I explore some tax saving tips for directors of family and personal companies. As circumstances differ, it is recommended to take professional advice.

As long as your income for 2017/18 is less than £100,000, you are entitled to a personal allowance of £11,500. Where income exceeds £100,000, the personal allowance is reduced by £1 for every £2 by which income tops £100,000. This means that anyone with income of more than £123,000 loses their personal allowance; whereas those with income between £100,000 and £123,000 have a reduced personal allowance.

Assuming you are entitled to a personal allowance, it is sensible to make use of it by extracting income up to that level. This may be in the form of dividends, salary or benefits-in-kind. What is important is that it is not wasted, as it cannot be carried forward – it is a case of ‘use it or lose it’. 

If you cannot use all of your personal allowance and are married or in a civil partnership, remember the marriage allowance allows you to transfer 10% of your personal allowance (i.e. £1,150) to your spouse or civil partner as long as they are not a higher or additional rate taxpayer. This will save a couple £230. 

It is usually tax-efficient to take a small salary and to extract further profits as dividends. All individuals are entitled to a dividend allowance in addition to their personal allowance. This is set at £5,000 for 2017/18. Once the allowance (and any unused personal allowance) have been used up, dividends are taxed at 7.5% to the extent that they fall within the basic rate band, 32.5% to the extent that they fall within the higher rate band and 38.1% where they fall within the additional rate band.

As the tax year end approaches, review the dividends that have been paid in the year and also the level of retained profits. Consider the position of all taxpayers and, if retained profits are sufficient, pay dividends to use up the dividend allowance and any unused personal allowance of the shareholders. If it is desirable to extract further profits, aim to use up the basic rate bands of shareholders before incurring a higher or additional rate liability. An ‘alphabet’ share structure provides the flexibility to declare different dividends for different classes of share, and to tailor the dividend policy to the circumstances of each family member.

Timing of dividends is particularly important this year, as the dividend allowance falls to £2,000 from 6 April 2018. Where the 2017/18 allowance has not been used and there are no plans to pay a dividend until after 6 April 2018, it may be sensible (if profits allow) to advance the payment date to before 6 April 2018 to enable more dividends to be extracted tax-free (and to leave the 2018/19 allowance available for dividends declared later in 2018/19).

The company must have sufficient retained profits to pay a dividend, and dividends must be properly declared.

It is important that the director’s loan account is reviewed before the end of the tax year, as well as before the company year-end. Where the account is overdrawn, consideration should be given to how this will be cleared; and where this is to be done by means of a dividend or bonus, which tax year it is beneficial for it to fall into. Where there are unused personal or dividend allowances for 2017/18 and the loan account is overdrawn, it may be worthwhile paying a bonus or dividend in 2017/18 to clear part of that balance while using up 2017/18 allowances that would otherwise go to waste. It would also be beneficial to ensure that the loan account balance remains below the £10,000 trigger for a benefit-in-kind charge.

It should be remembered that where a loan to a director has not been repaid within nine months of the company’s year-end and the company is a close company, a tax charge equal to 32.5% of the outstanding balance must be paid to HMRC. The director will also suffer a benefit-in-kind charge if the loan balance exceeds £10,000 at any point in the tax year – even if only for one day.

For those reaching state pension age on or after 6 April 2016, 35 qualifying years are needed to qualify for the full single-tier state pension. Where a director does not already have 35 qualifying years, consideration should be given to paying sufficient salary (or a bonus) to make the year a qualifying year.

If a salary has not been paid on an ongoing basis throughout the year, there is no need to panic. There is still time to make 2017/18 a qualifying year. Directors have an annual earnings period for National Insurance contributions (NICs) purposes, and here this is an advantage. Where a salary has not been paid so far in the tax year, it is possible to make a salary or bonus payment up to the primary and secondary threshold without triggering a National Insurance liability, and as long as the amount paid is more than the lower earnings limit, the year counts as a qualifying year (as notional zero rate contributions are treated as paid where the payment falls within this band). For 2017/18, it is possible to earn a free qualifying year as long as the salary/bonus for the year is between £5,876 and £8,164. 

A tax-efficient profit extraction salary usually combines paying a salary up to the level of the primary NICs threshold (£8,164 for 2017/18) where the employment allowance is not available and up to the level of the personal allowance (£11,500 for 2017/18) where it is. Beyond this point, it is usually more efficient to extract profits as dividends.

Review the salary paid for 2017/18, and where it is less than the optimal amount, make it up to this level in March. As noted above, paying sufficient salary (or a bonus to top it up) will ensure that the year is a qualifying year for National Insurance purposes. 

It is possible to make tax-relieved pension contributions up to the level of the available annual allowance. Aside from the valuable tax relief, making pension contributions can be a useful way to reduce income to preserve the personal allowance or to prevent the high-income child benefit charge from biting. The company can also make pension contributions if the annual allowance is unused.

Therefore, review pension contributions and decide if it would be beneficial to make further contributions before the end of the tax year.

Don’t forget family members. In a family company scenario, consider whether other family members have personal or dividend allowances that can be utilised, and whether they have used up their basic rate band. It generally makes sense to equalise income where possible to ensure that tax is not paid at the higher and additional rates until necessary. 

Likewise consider making pension contributions for family members. 

Don’t leave it too late - the year-end deadline is approaching. Remember that 2017/18 personal and dividend allowances not used by 5 April 2018 will be lost.