Surplus Profit - How best to use it?

[The Blind Man]

Hi all,

As the title suggests I'm having a decent year, but I am not counting my chickens just yet.

Me - sole trader / selling blinds to Joe Public and some commercial / no bad debts / paid on completion cheque or cash .

I am in a position where it is entirely possible that by the end of March 2009 I could well have made sufficient profit to clear all of my 2010 overheads which includes a basic salary that I have been paying myself during my first 2 years trading aswell as accruals for projected VAT bills, fuel, tax and pretty much anything I can else I can think of.

I was wondering how best to use this surplus. Should I;

a) Declare it as profit, take the tax hit and use it to allow myself to pay myself more next year and enjoy the fruits of my labour?
b) Take it out of the company in March as a one off salary payment and reinvest it back into the company to cover the overheads (is this the same as a) above?)

I'm just wondering how best to utilise it in terms of minimising my tax on profit / salary, whilst keeping in mind that things next year may not be as good as this, and remaining cash rich will enable me to ride out a rough patch and assist in competetive pricing when required.

On a side note would this proclude me from working tax credits, that I currently qualify for?

Any thoughts?

 

[DuaneJackson]

I don't get why, if you have a lot of money sitting there - you're seeking free advice on a forum.

Surely the best advice anyone here could give you would be to speak to your accountant and an IFA.

 

[adam]

Harsh Duane but I see your point.

Then again, others on here might want to know the answer to a similar question.

 

[DuaneJackson]

Sorry, I didn't mean it to come across as being harsh.

I don't think there is an "answer". The best solution would depend on a number of personal factors

 

[Intel Clarke]

We believe it boils down to wanting to invest into something long term, safe and efficient - or - you want to draw it down and enjoy.

BUT please - do not pay yourself, pay the tax on it and then have to re-invest the cash into the business again!

With both options - bear in mind how gloomy next year looks, if you take cash out, you may need to put it back in to pay yourself!!

Best of luck what ever you decide. If it is something you want to talk more about, feel free to mail us.

Rgds
Intelc

 

[The Blind Man]

Not harsh at all Duane, I entirely see your point.

I do have an accountant who, is probably best placed to advise. I am just wondering what a good strategy would be in the position I find myself in.

Am I right to be cautious and leave the money in the business or are there ways to minimise the tax burden, is kind of what I was wondering.

And thanks to Intel Clarke, i guess what you say is pretty obvious really. I'm just brainstorming with myself at the moment.

 

[David Griffiths]

If you are a sole trader, what you pay yourself has no bearing on your tax liability, which is calculated based on profits earned, whether you've paid yourself or not.

Intel's comment on paying yourself doesn't have any bearing on your liability. It may be relevant to a limited company but not to a sole trader for the reasons stated above

 

[Intel Clarke]

If you are a sole trader, what you pay yourself has no bearing on your tax liability, which is calculated based on profits earned, whether you've paid yourself or not.

You pay yourself tomorrow, but you still have to declare it as payment/drawing of some sort the next time round you submit an annual return. So you will pay the tax on it.

Unless of course, you draw the money out and have to put it back in before the end of the accounting period - and if that is a possibility now; we suggest that you should be more prudent in what you draw from your business.

 

[David Griffiths]

You pay yourself tomorrow, but you still have to declare it as payment/drawing of some sort the next time round you submit an annual return. So you will pay the tax on it.

Unless of course, you draw the money out and have to put it back in before the end of the accounting period - and if that is a possibility now; we suggest that you should be more prudent in what you draw from your business.

:|

Sole traders pay tax on their business profits. What they draw from the business is irrelevant.

To use the example given by Mr Micawber (updated for decimal curerency!), if they make £20 in the year and drawn £19.94, they pay tax on the £20

If they make £20 in the year and draw £20.06, they pay tax on the £20.

It matters not that they pay the £0.06 back in to the business in the following year. Or if they don't.

Drawings are completely irrelevant to tax liabilities. You don't pay tax on drawings. Full stop.

 

[Intel Clarke]

That is nonsense, over any closed cycle - you will pay the tax

 

[PhilDPho]

You're both saying the same things in different ways.

One is saying you pay tax regardless, the other is saying you pay tax but not for drawing.

I think what David is trying to say is that he won't pay tax on the drawings but will still pay it on profit as it's not an allowable expense.

You're saying the same, but differently.

 

[David Griffiths]

We are clearly not on the same wavelength.

 

[elaine@cheapaccounting]

Hi all,

Me - sole trader

I am in a position where it is entirely possible that by the end of March 2009 I could well have made sufficient profit to clear all of my 2010 overheads which includes a basic salary that I have been paying myself during my first 2 years trading aswell as accruals for projected VAT bills, fuel, tax and pretty much anything I can else I can think of.

I was wondering how best to use this surplus. Should I;

a) Declare it as profit, take the tax hit and use it to allow myself to pay myself more next year and enjoy the fruits of my labour?
b) Take it out of the company in March as a one off salary payment and reinvest it back into the company to cover the overheads (is this the same as a) above?)

I'm just wondering how best to utilise it in terms of minimising my tax on profit / salary, whilst keeping in mind that things next year may not be as good as this, and remaining cash rich will enable me to ride out a rough patch and assist in competetive pricing when required.

On a side note would this proclude me from working tax credits, that I currently qualify for?

Any thoughts?

As David has rightly said, as a sole trader (which is not a company) you pay tax on profits in the year earned.

As the owner you do not pay yourself a salary - this is not an allowable expense, see the notes to the self employed self assessment sheet here:

http://www.hmrc.gov.uk/worksheets/sa103f-notes.pdf

Maybe you are getting the operation of a sole trader missed up with how a limited company operates. But in any case the limited company would still have to pay tax on its profits.

Also do bear in mind that your earnings will impact on tax credits and you should inform HMRC of any changes in circumstances since the claiming of tax credits.

Hope this helps but you may need to seek the advice of an accountant if you are unsure about how a sole trader should operate.

Anyway well done on your successful business.

At least it isn't curtains for you

(Oh - I just couldn't resist - sorry :redface

 

[adam]

Ok maybe not harsh Duane, I just had one of my softer "let's be nice" moments!

Good answers none the less.

 

[edmondscommerce]

At least it isn't curtains for you

(Oh - I just couldn't resist - sorry :redface

lol

Is there anyway of salting the cash away so it is not regarded as a profit but could be liquidated later on should teh need arise?

 

[elaine@cheapaccounting]

lol

Is there anyway of salting the cash away so it is not regarded as a profit but could be liquidated later on should teh need arise?

not legally!

If there was - everyone would be doing it

 

[APC Nexday Overnite Ltd]

invest in another man, tools, van, advertising etc then next year with your continued growth you'll have an even bigger pile maybe. Think about how you can expand your business and make it even bigger

 

[HAZEL B]

"Sole traders pay tax on their business profits. What they draw from the business is irrelevant."

Not nonsense, absolutely right

 

[Intel Clarke]

You are getting lost on a technicality and making life harder than it needs to be for any non-accountant

Drawings sit on the balance sheet hence profits are higher than if you paid yourself a salary or bonus.

By taking a drawing, you are paying tax on the 'higher' sole trader profits - and hence still paying the tax.

The tax will be paid either way and all at the marginal rate.

I can see the confusion from my original post however where I said "Pls don't pay yourself, pay the tax and then have to re-invest the money." I only said this as The Blind Man does pay himself a salary.

 

[Zeno]

You are getting lost on a technicality and making life harder than it needs to be for any non-accountant

Drawings sit on the balance sheet hence profits are higher than if you paid yourself a salary or bonus.

By taking a drawing, you are paying tax on the 'higher' sole trader profits - and hence still paying the tax.

The tax will be paid either way and all at the marginal rate.

I can see the confusion from my original post however where I said "Pls don't pay yourself, pay the tax and then have to re-invest the money." I only said this as The Blind Man does pay himself a salary.

The Blind Man is a sole trader - how can he pay himself a salary?

 

[Intel Clarke]

Of course sole traders can register as employers, pay themselves as well as have employees.

 

[HAZEL B]

You are getting lost on a technicality and making life harder than it needs to be for any non-accountant

Drawings sit on the balance sheet hence profits are higher than if you paid yourself a salary or bonus.

By taking a drawing, you are paying tax on the 'higher' sole trader profits - and hence still paying the tax.

The tax will be paid either way and all at the marginal rate.

I can see the confusion from my original post however where I said "Pls don't pay yourself, pay the tax and then have to re-invest the money." I only said this as The Blind Man does pay himself a salary.

Not a technicality but an extreemly important distinction. If a sole trader fills in his tax credit form on the basis of the amount he draws per week rather than his profits for the year then the result could cause all sorts of trouble.

 

[taxattack]

Hi all,

As the title suggests I'm having a decent year, but I am not counting my chickens just yet.

Me - sole trader / selling blinds to Joe Public and some commercial / no bad debts / paid on completion cheque or cash .

I am in a position where it is entirely possible that by the end of March 2009 I could well have made sufficient profit to clear all of my 2010 overheads which includes a basic salary that I have been paying myself during my first 2 years trading aswell as accruals for projected VAT bills, fuel, tax and pretty much anything I can else I can think of.

I was wondering how best to use this surplus. Should I;

a) Declare it as profit, take the tax hit and use it to allow myself to pay myself more next year and enjoy the fruits of my labour?
b) Take it out of the company in March as a one off salary payment and reinvest it back into the company to cover the overheads (is this the same as a) above?)

I'm just wondering how best to utilise it in terms of minimising my tax on profit / salary, whilst keeping in mind that things next year may not be as good as this, and remaining cash rich will enable me to ride out a rough patch and assist in competetive pricing when required.

On a side note would this proclude me from working tax credits, that I currently qualify for?

Any thoughts?

You say you are a "sole trader", but you also refer to "the company", which is causing confusion.

Are you a) a sole trader, and by "the company", mean your business; or are you b) operating as a single member registered company?

If a), you pay tax on your profit, irrespective of what you pay yourself. If b) you have more flexibility over what you extract from the company, and therefore the amount of tax which the company (Corp Tax), and yourself pay.

Chris

 

[taxattack]

Of course sole traders can register as employers, pay themselves as well as have employees.

In law it is not possible to contract with oneself.

Chris

 

[Mattonella Tile Studio]

Of course sole traders can register as employers, pay themselves as well as have employees.

Sole traders can register as employers yes, but they can only pay their employees. What they 'pay themselves' is drawings, which is effectively a payment against the profit the business makes. They, themselves, are the business so business profit equals personal 'pay' regardless of whether it's all drawn.

 

[taxattack]

You're both saying the same things in different ways.

One is saying you pay tax regardless, the other is saying you pay tax but not for drawing.

I think what David is trying to say is that he won't pay tax on the drawings but will still pay it on profit as it's not an allowable expense.

You're saying the same, but differently.

David is not saying that sole traders do not pay tax on drawings.

 

[Zeno]

Of course sole traders can register as employers, pay themselves as well as have employees.

I would be careful posting answers like this with your name and company details.

While I am at it, I would also be careful of calling the advice of a respected member of ther forum nonsense.

 

[Davem1234]

I have resisted getting involved in this one but David is correct.

A sole trader is taxed on profits and takes drawings as and when required but the drawings do not affect the tax bill. The profits (not the drawings) are shown on the individuals self assessment tax return.

A limited company pays corporation tax on profits, after deduction of directors salaries. The shareholders (they are often also directors) can take dividends but these do not affect the tax the company pays.

I probably haven't added anything to this discussion but I'm just trying to state the facts before people start getting frustrated and start insulting each other!!

 

[Intel Clarke]

Of course sole traders can register as employers, pay themselves as well as have employees.

That was a silly thing to write, I do apologise.

I did mean they can be employers and pay others, of course not themselves.

 

[Wild Goose]

Intel Clarke, when you're in a hole you should stop digging. You're original contention couldn't be more wrong - David, Elaine, Hazel and others have told you why - and you are only shovelling yourself in deeper by adding your misconception that the self-employed can pay themselves via PAYE.

This is first lesson of the first year stuff for anyone on a bookkeeping course. Go and stand in the corner and face the wall!

To dispel any doubt over The Blind Man's status, he is (as he stated) self-employed (and not a one man band limited company). From another thread of his:

I am registered as self employed, pay tax & NI, and recently VAT registered. I work from home as a self employed blinds installer. This is basically a franchise ....

Where do I stand? I'm not a Limited company ....

There you have it from the horse's mouth. Hey, just like Ling.

 

[Intel Clarke]

I have resisted getting involved in this one but David is correct.

A sole trader is taxed on profits and takes drawings as and when required but the drawings do not affect the tax bill. The profits (not the drawings) are shown on the individuals self assessment tax return.

A limited company pays corporation tax on profits, after deduction of directors salaries. The shareholders (they are often also directors) can take dividends but these do not affect the tax the company pays.

I have confused the company / sole trader view and DaveM and David are correct. The drawings/capital introduced for The Blind Man do not change the tax position as dividends and share purchases do not for the Limited Company ( A good analogy DaveM).

 

[Wild Goose]

That was a silly thing to write, I do apologise.

I did mean they can be employers and pay others, of course not themselves.

Your first misconception - that the self-employed pay tax on their drawings rather than their profits, was also a silly thing to write.

Blind Man, Elaine is right you need to talk to an accountant. The fact that it is easier for you to ask here rather than speak to your accountant doesn't bode well. The avenues you might want to explore, from a tax viewpoint, are:

1 Changing to limited company status, whereupon you might take profits as salary/divs mixture and save tax;

2 If you prefer to remain self-employed, there may be some scope for you to postpone tax (and sometimes save tax, in spite of Intel Clarke's "closed cycle"), by changing your year end accounting date.

You need specialist help (tax specialist, that is). Careful - you could be signing an open cheque, as the work may become complex and time-consuming for your accountant.

Good luck!

 

[Davem1234]

Wild Goose - although I agree that the original poster should get tax advice from their accountant, it shouldn't ever be an open cheque as fees should be agreed in advance.

 

[Wild Goose]

Wild Goose - although I agree that the original poster should get tax advice from their accountant, it shouldn't ever be an open cheque as fees should be agreed in advance.

Hey DaveM,

Fact is not many accountants do agree fees in advance. Many rely on their letter of engagement which of course "agrees" that the client will pay time-based fees.

I know where you're coming from - Blind Man should get an estimate because accountants are no different to builders or plumbers or roofers or mechanics or taxi-drivers... they'll fleece our poster, given half a chance.

Did I miss anyone?

 

[APC Nexday Overnite Ltd]

Us here get the bank statements and place a number next to each and every outgoing. We then match up the invoice/receipt by placing same number on invoice/receipt as whats in the bank statements.... "portfolioing" this saves us massively each year (thousands) on accounts. Its worth while doing and when speaking to the accountant he himself said thats what they do anyway us doing it though sames them massive amounts of time.

 

[Davem1234]

Wild Goose - its true that some accountants fleece their clients but clients do vote with their feet.

I am an accountant and always agree fixed fees with my clients. They are happy knowing that even if the tax bill is sometimes a shock, my fees are not!!

More and more accountants now offer fixed fees and in my experience they pay my bills quicker as they know what's coming rather than other firms who surprise their clients once a year.

 

[Wild Goose]

Wild Goose - its true that some accountants fleece their clients but clients do vote with their feet.

Are they thalidomide?

I am an accountant and always agree fixed fees with my clients. They are happy knowing that even if the tax bill is sometimes a shock, my fees are not!!

The tax bill is rarely a shock to my clients, although my fees sometimes are. But nobody's complained - they'd be penny-wise but pound-foolish if they did.

More and more accountants now offer fixed fees and in my experience they pay my bills quicker as they know what's coming rather than other firms who surprise their clients once a year.

You've been reading Ronald Baker's "Professional's Guide To Value Pricing" (or talking to one of his West-coutry disciples).

Fixed prices are a great idea for those who like eating at a carvery - pay a fixed price and eat as much as you like; fill your boots! For me the idea is flawed for two reasons:

first off, there are too many people who will abuse it by calling you every day for little or no reason - you could be half your day listening to clients who have no mates in the pub to use as sounding boards - and you'll be doing it for free!

Secondly, there are a lot of people who don't mind paying a fair price for a service - they are in business themselves, and understand that time is money. If they call they get charged; if they're self-sufficient they get charged less. These latter people are not at home paying a fixed price in a carvery - they prefer to pay for whatever they themselves eat. Like someone going dutch on a round of drinks.

 

[Davem1234]

Well that's your experience.

My clients do not abuse the fixed rate system but if they did you simply tell them that the fee next year will higher for the service they require (and quote a figure). They can accept this or look elsewhere. If they are happy with you being a replacement for "the man down the pub" then they will stay with you.

Fixed fees don't mean fixed forever.

And you said that client's don't mind paying a fair price for a service - I don't remember disagreeing with that!! If I pitch the fixed fee correctly then my fees should be about the same as if I based them on hourly rates. The differences are that the clients know exactly the cost, I don't have to keep timesheets and I don't have to have a argument with them over fees once I have all the work done.

 

[Wild Goose]

If I pitch the fixed fee correctly then my fees should be about the same as if I based them on hourly rates. The differences are that the clients know exactly the cost, I don't have to keep timesheets and I don't have to have a argument with them over fees once I have all the work done.

Would you use a "change order" and give a separate quote for say the service I'd suggested (reviewing the poster's tax affairs and implementing change to a limited company or year-end change date). Or would you regard it as part of and stick to the fixed fee you had already quoted for the year? Maybe up their fixed fees next year to compensate?

I'm interested to know because that's been the struggle with value pricing for me - whenever I'd listen to someone (for free) and say at the end of the conversation "Yes indeedee we can help you with that - I'll send out a fixed price agreement for the anticipated work" then some clients would want the work done for free as part of the annual fixed price agreement. If that were to happen, you could of course end up with the tamer clients subsidising those trying to score a deal on you.

 

[Davem1234]

It depends how much work is likely to be involved.

If it is something that will take a couple of hours I tend to think this is included in the fixed fee. If it is a couple of days work then I would say I can do this but it I will have to give you an extra bill for £xxx once the work is done.

There are always clients that ring you more than others and indeed some you don't hear of from one year to the next but when it comes to reviewing the fees for next year, some can stay the same and others can be increased a bit ... the point is that the new fee (if necessary) is agreed up front.

Also I try not to think that conversations are "for free" otherwise you are only interested in the year end accounts/tax return work once a year. I try to give a good service when needed irrespective of how long it will be until I can send another bill to the client.

I also remember that I want to keep the client not just get a hundred pounds more this year and then they leave for someone else to get all future fees.

Dave