First of all, well done! You’ve clearly done well with your business, and are starting to think about paying tax (a necessary evil, I think that we’ll all agree), and you need some kind of idea of how much to put aside.
Let’s take a look at this.
You’d think that it would be simple, wouldn’t you? But let’s start with the basics.
It’s generally thought that you save around 30% of your sales, in order to save for your self assessment, and given that basic rate tax is 20%, and national insurance is currently 9%, this makes the 30% about right.
Let’s look at some figures.
I’m basing this on a simple sole trader, with no other earnings other their business income.
Say for example, your business income is £25,000, the general consensus is that you would save around 30% of that, which would be £7500. Great, I hear you say! I’ll read no further, numbers bore me anyway. I now have £7500 in the bank, and am feeling pretty rich right now.
But let’s look at how much tax you may actually pay.
You actually pay tax on your profit (or earnings), not your turnover, so let’s look at this again.
If your sales are £25,000, but your expenses are £8,000, your actual profit is £17,000. (I’m keeping things really simple here, and not including any accounting adjustments).
So, you save 30% of £17,000? No.
Don’t forget, you have your personal allowance to consider, which for the 2019-20 tax year is £12,500. Take this from your profit of £17,000, and this leaves you with £4500 taxable income. That’s a touch better than the £25,000 we originally thought, isn’t it?
The £4500 calculates out as £900 to pay in income tax.
This is a different animal however, and is calculated quite differently. No Class 2 national insurance is due until a profit figure of £6365 is reached, and then it is calculated at £3 per week.
Class 4 is due once the profits reach £8632, and are calculated at 9% once that figure has been reached.
So, under our example shown, with a profit figure of £17,000, the national insurance due is as follows:
Class 2 – £156.00 (it kicks in at £3 per week)
Class 4 – £753.12
Add our tax calculation to this, and the total amount due is £1809.12. Add on your payments on account, (more about those here), and your total bill is nearer £2713.
You’ve saved £7500, but only need to pay £2713. Happy days. You’re probably feeling a bit smug now, aren’t you?
On a serious note, it’s a good mindset to be in.
But, if you have a good handle on your finances, and have a rough idea of how much your tax bill may potentially be, you can reduce that 30% down to around 15% (£3750), and still have some left over in the bank.
There’s no magic formula that I can give you to calculate this. There are too many variables, such as other income, low expenses, reduced turnover, greatly increased turnover etc. But, as a rough guide (And I’m talking ‘rough as a bear’s whatsit’ kind of rough), the 30% is a good place to start.
Why not start today? Look at your turnover, look at your expenses, and see if you can start to inch towards knowing your profit figure? It won’t hurt, surely? And it’s a great way to feel in control.
It’s better to do this at the start of the year, to really have the information at your fingertips, but needs must. Do it today.