One of the biggest causes of unnecessary stress for business owners is receiving a tax bill without having enough money set aside for it. It’s easily done. You look at your business bank balance, see that there’s plenty of cash available and assume you’re in a healthy position. The problem is that some of that money may effectively already be earmarked for HMRC.
So, how much should your business set aside for tax?
Unfortunately, there isn’t one percentage that works for every business. The amount you need will depend on your business structure, profits, VAT position, payroll and, for company owners, how you take money out of the business.
What you can do, however, is plan for tax regularly rather than waiting until a deadline is approaching.
How much should a limited company set aside for Corporation Tax?
Limited companies pay Corporation Tax on their taxable profits. Unlike some other business expenses, Corporation Tax isn’t normally leaving your bank account every month. That can make it very easy to overlook while you’re looking at your day-to-day cash position.
Currently, the main rate of Corporation Tax is 25%, while companies with profits of £50,000 or less generally pay the 19% small profits rate. Marginal Relief can apply where profits fall between the relevant limits, although these thresholds can be affected if you have associated companies.
This doesn’t mean every limited company should simply move 25% of its income into a tax account. Corporation Tax is based on taxable profits, not turnover, and the actual amount due will depend on your circumstances. A better approach is to estimate your likely Corporation Tax liability based on your current financial performance and regularly set aside an appropriate amount. That turns the eventual bill into something you’ve planned for rather than an unwelcome surprise.
Don’t forget about VAT
If your business is VAT registered, it’s important to remember that the VAT you collect from customers isn’t additional business income. You’re collecting it before accounting for VAT to HMRC, after taking into account VAT you are entitled to reclaim and the VAT scheme you use. Problems can arise when VAT receipts are allowed to build up in the main business bank account and are then used to cover everyday expenses.
When the VAT payment is due, the business suddenly has to find the money again. Keeping money earmarked for VAT separate, or regularly transferring an estimated amount into a dedicated tax account, can make managing your VAT payments much easier.
Allow for PAYE and National Insurance
If your business employs staff and runs payroll, you may also have PAYE and National Insurance liabilities to pay to HMRC. These amounts can change as your payroll changes. Taking on new employees, increasing salaries, paying bonuses or changing how directors are remunerated can all affect the amount you need to pay. Employer National Insurance is another business cost that needs to be considered alongside the PAYE and employee National Insurance deducted through payroll.
Keeping an eye on these liabilities throughout the year helps prevent payroll taxes becoming an unexpected drain on cash flow.
How much should sole traders set aside for tax?
For sole traders, Income Tax and National Insurance are generally dealt with through Self Assessment. Again, there isn’t a single percentage that every sole trader should save. Your eventual bill will depend on factors including your taxable profits, other sources of income, available allowances and your individual circumstances.
There’s another important consideration too: payments on account. Depending on your tax position, HMRC may require advance payments towards your next Self Assessment bill. This can make the amount due significantly higher than a new business owner was expecting if they haven’t planned for it. Regularly putting money aside as your business earns it can make Self Assessment deadlines much easier to manage.
Company owners may have personal tax to pay too
Running a limited company can create another potential tax planning issue. Your company and you personally are separate for tax purposes.
The company may have paid or provided for its Corporation Tax, but that doesn’t necessarily mean all the tax relating to the money you’ve taken from the business has been dealt with. If you’re a director or shareholder and receive dividends, for example, you may have personal tax to pay through Self Assessment depending on your circumstances. This can catch people out because the company’s finances appear to be completely up to date while a personal tax liability is quietly building in the background.
Good tax planning should therefore consider both the company’s position and the personal position of its owners.
Should you have a separate bank account for tax?
One of the simplest ways to improve your tax planning is to create a separate savings account specifically for tax. As liabilities build up, you can regularly transfer money from your main business account into your tax account.
Depending on your business, that could include money earmarked for:
- Corporation Tax;
- VAT;
- PAYE and National Insurance; and
- personal Self Assessment liabilities.
You don’t necessarily need a different bank account for every individual tax. The aim is simply to make it harder to accidentally spend money you’ll later need for HMRC. If the money is sitting in your everyday business account, it’s very easy to treat it as available cash. Moving it somewhere else provides a much more realistic picture of how much money the business actually has available to spend.
Plan for tax monthly, not annually
Tax planning shouldn’t be something that happens once a year when your accounts are prepared or a deadline is approaching. Looking at your numbers regularly allows you to estimate what your tax liabilities are likely to be and check whether you’ve put enough money aside. It also gives you time to react.
If profits are considerably higher than expected, for example, you can increase the amount you’re saving rather than discovering months later that your tax bill has jumped too. Likewise, if cash flow is becoming tight, spotting the problem early gives you more options than waiting until a tax payment is due.
So, what percentage should you put aside for tax?
It’s tempting to look for a simple answer, 20%, 25%, 30%, but a blanket percentage can give a false sense of security. Two businesses with exactly the same turnover could have completely different tax liabilities because their profits, business structures, VAT arrangements, payroll costs and owners’ personal circumstances are different.
Rather than relying on a generic percentage, work from your actual numbers. Understand what taxes apply to your business, estimate what you’re likely to owe and build those amounts into your cash flow planning. The most important thing isn’t finding a magic percentage. It’s making sure tax is being planned for before the bill arrives.
Need help planning for your business tax bills?
At Greystone Advisory, we help business owners understand what’s building up, plan their cash flow and prepare for future tax payments. If you’re unsure how much your business should be putting aside for Corporation Tax, VAT, PAYE, Self Assessment or other tax liabilities, we can help you get a clearer picture.
Get in touch with Greystone Advisory to discuss your business and tax planning.
