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Understanding how much to set aside for tax is crucial for both limited companies (Ltds) and sole traders. While the specific amounts will vary based on income, expenses, and personal circumstances, this guide provides a general guide for monthly, bi-annual, and annual tax planning.

Key differences in tax structure

Before diving into figures, it’s important to grasp the key differences in how Ltds and sole traders are taxed:

  • Sole Traders: The individual and the business are legally the same entity. Business profits are treated as personal income and are subject to Income Tax and National Insurance Contributions (NICs).
  • Limited Companies: The company is a separate legal entity from its owners and directors. The company pays Corporation Tax on its profits. Directors, employees and shareholders then pay personal taxes on any salaries, dividends, or other benefits they receive from the company.

Sole trader tax planning

Sole traders are responsible for paying Income Tax and Class 2 and Class 4 National Insurance contributions on their business profits. Payments are typically made through Self Assessment.

Income tax

  • Tax-Free Personal Allowance: £12,570 (for the 2024/2025 tax year).
  • Basic Rate (20%): On profits between £12,571 and £50,270.
  • Higher Rate (40%): On profits between £50,271 and £125,140.
  • Additional Rate (45%): On profits above £125,140.

National Insurance Contributions (NICs)

  • Class 2 NICs: A flat weekly rate (£3.45 for 2024/2025) if your profits are above a certain threshold (£6,725 for 2024/2025). This can sometimes be voluntary for lower profits.
  • Class 4 NICs: A percentage of your profits above certain thresholds (9% on profits between £12,570 and £50,270, and 2% on profits above £50,270 for 2024/2025).

Tax saving strategies for sole traders

A good rule of thumb for many small to medium-sized businesses is to set aside 20% to 30% of your company’s net profits. Consider the pros and cons of how often you set money aside for tax planning.

Monthly

  • This allows for regular savings and avoids large lump sums. You should adjust throughout the tax year based on the annual profit your business is projected to achieve.

Bi-annually

  • Less frequent saving but still requires you to check in with profit performance.

Annually

  • Making one large lump sum once in the tax year is generally more suitable for those with stable, predictable income.

Let’s look at an example. Let’s say your annual profit is £40,000, you might set aside:

  • Income Tax: (40,000 – 12,570) * 0.20 = £5,486
  • Class 2 NICs: £3.45 * 52 weeks = £179.40
  • Class 4 NICs: (40,000 – 12,570) * 0.09 = £2,468.70
  • Total Estimated Tax: £5,486 + £179.40 + £2,468.70 = £8,134.10
  • Monthly Saving: £8,134.10 / 12 = £677.84

This represents approximately 20% of your gross profit in this example, but higher earners will need to set aside a larger percentage due to higher tax rates.

 

Limited company tax planning

Limited companies pay Corporation Tax on their annual profits. Directors then pay personal taxes on salaries (via PAYE) and dividends they draw.

Corporation Tax

  • Small Profits Rate (19%): For companies with profits of £50,000 or less.
  • Main Rate (25%): For companies with profits over £250,000.
  • Marginal Relief: For companies with profits between £50,001 and £250,000, the tax rate gradually increases from 19% to 25%.

Director’s Personal Income (Salary and Dividends)

  • Salary: Subject to PAYE (Income Tax and Employee/Employer NICs).
  • Dividends: Paid from post-Corporation Tax profits. Dividends are subject to specific dividend tax rates after a tax-free dividend allowance (£500 for 2024/2025):
    • Basic Rate (8.75%)
    • Higher Rate (33.75%)
    • Additional Rate (39.35%)

Tax saving strategies for Ltds

The most accurate way to determine how much to set aside is to keep meticulous records of your company’s income and expenses throughout the financial year. This will allow you to project your profits and your Corporation Tax needs.

A good rule of thumb for many small to medium-sized businesses is to set aside 19% to 25% of your company’s net profits. This range accounts for the various Corporation Tax rates and provides a buffer. If your profits are consistently higher, you might need to adjust this percentage upwards.

You could consider:

  • Profitability: The more profitable your company is, the more you’ll need to set aside.
  • Tax Allowances and Reliefs: Don’t forget to factor in any available tax allowances, such as capital allowances for equipment purchases, and reliefs that could reduce your taxable profits.
  • Future Growth: If you anticipate significant growth in the coming year, your profits (and therefore your tax liability) are likely to increase.

 

Monthly

  • At the end of each month, review your profit and loss for that month and transfer a calculated percentage (e.g. 19-25%) of your net profit into a separate savings account dedicated to Corporation Tax.
  • This reduces the impact on cash flow, makes budgeting easier, and provides a clear picture of your tax liability as it accrues.

Bi-Annually 

  • Calculate your accumulated profits twice a year and set aside the appropriate percentage.
  • This requires less frequent transfers than monthly, but can lead to larger lump sums being set aside, which might be challenging for cash flow if not planned carefully. Plus, if profits are less stable, you also run a higher risk of not saving enough.

Yearly

  • Calculate your full year’s profit and tax liability after your financial year-end and then set aside the entire amount.
  • This approach can put immense pressure on your cash flow. Finding a large sum of money at short notice can be difficult and may even necessitate borrowing if not adequately planned for. It also increases the risk of financial strain if your profits were higher than anticipated.

 

Earn on tax savings

The monthly approach promotes good financial discipline, helps manage cash flow effectively, and reduces the stress associated with large tax bills – especially businesses that are growing or have variable income.

Setting money aside in an easy-access savings account with a competitive rate, like the Moneybox Business Saver, is a great way to not only stay on top of your tax liabilities but earn interest on your savings too. Start earning 3.75% AER (variable) on your business’ cash today.

 

 

We do not offer personal tax advice or make specific recommendations based on your individual circumstances. If needed, seek independent advice from a qualified tax professional

 

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