Small business owners have to pay a number of different taxes depending on their structure and income. It can, however, be overwhelming to keep track of every single one for each specific case.
To help you avoid making mistakes on which ones to pay and how much, this article will go through the six major taxes that just about every small business has to be familiar with.
1. Income Tax
If you are a sole trader, you have to pay income tax on the profits you make with your small business. However, you only start getting taxed on those profits if your income is over the tax-free Personal Allowance limit of £12,500.
There are certain conditions that change the Personal Allowance limit. If you claim Marriage Allowance or Blind Person’s Allowance, your Personal Allowance may be bigger. If your taxable income is over £100,000, it’s smaller.
Limited company directors’ income, whether it’s a salary or dividends, is taxed at source via their PAYE scheme.
Where your profits fall under the income tax band determines your tax rate:
- 20% of your income is taxed if you make £12,501 to £50,000
- 40% of your income is taxed if you make £50,001 to £150,000
- 45% of your income is taxed if you make over £150,000
Your income tax must be paid to HMRC before 31 January every year. If you are making payments on account, you have a second deadline of 31 July every year.
2. National Insurance
Sole traders that make more than the Small Profits Threshold of £6,365 a year have to pay Class 2 National Insurance Contributions (NICs). These are flat-rate payments that are due on the same date as your income tax. The rate for 2020-21 Class 2 NICs is £3.05 a week.
If your business makes less than the Small Profits Threshold, you still have the option to pay Class 2 NICs to contribute to your State Pension and for other state benefits.
If your business makes more than £8,631, you have to pay Class 4 NICs on top of Class 2 NICs. The tax rate for Class 4 NICs is 9% on £8,632 to £50,000 in taxable profit. Profits over £50,000 have a 2% tax. Payment has the same deadline as Class 2 NICs.
Limited company directors have their NICs automatically paid through the company’s PAYE.
You stop paying Class 2 NIC upon reaching State Pension age and Class 4 NIC on the start of the tax year after reaching State Pension age.
3. Corporation Tax
If you run a limited company, you have to pay corporation tax on your business’ profits. The tax is applied after salaries and other business expenses have been accounted for and before dividends are paid out.
The current corporation tax is at 19% for all companies, but it will be reduced to 17% at the start of the next tax year on 1 April 2020.
You have nine months and one day after the end of your business’ accounting year to pay your corporation tax. Companies with profits over £1.5 million a year have the option to pay in instalments. Filing your corporation tax returns must be done within 12 months.
Payment cannot be made with a personal credit card nor can it be done through the Post Office.
There are a number of reliefs such as capital allowances, R&D relief, and trading losses that limited companies can take advantage of to offset the corporation tax.
4. Dividend Tax
There is a dividend allowance of £2,000 that you don’t have to pay any tax on. Any dividends you receive over the allowance will then be taxed depending on your income band.
- Basic rate — 7.5%
- Higher rate — 32.5%
- Additional rate — 38.1%
You need to add the income you receive from your dividends with your other income to know which income band for your dividends you fall under.
If your only source of income is dividends from investments, you can use the Personal Allowance limit to receive those dividends without having to pay tax on them. You’re also able to use your dividend allowance in addition to your Personal Allowance to get even more income from your dividends tax-free.
When you go over your dividend allowance, you need to report to HMRC.
If you make up to £10,000 in dividends, you can do either of the following:
- Ask HMRC to change your tax code to get the tax from your salary or pension
- Include it in your Self-Assessment tax return
If you make over £10,000 in dividends, you need to submit a Self-Assessment tax return.
5. Value Added Tax (VAT)
Businesses that make more than the VAT threshold of £85,000 a year on VAT-taxable sales must register for VAT.
You need to start charging VAT on goods and services starting from the effective date of registration. The VAT rate depends on what is being sold. The standard VAT rate is 20%, with some goods and services at a reduced rate of 5%, and others being completely exempt.
It is mandatory that you report the amount of VAT you’ve charged and paid to HMRC in your VAT return. You must pay the difference if you charged more than you paid. You can reclaim VAT if you paid more than you charged. You can also reclaim VAT you paid on goods and services for your business.
VAT returns are due within 37 days at the end of every quarter. You are required to keep digital records and submit returns using Making Tax Digital (MTD)-compatible software.
There is also the VAT Flat Rate Scheme, which is an option for businesses with £150,000 or lower annual turnover. Under this scheme, you only have to pay a fixed rate instead of accounting for every single good or service you sell. You also get to keep the difference from what you charge customers and what you pay to HMRC. However, you cannot reclaim VAT on your purchases apart from specific capital assets.
6. Business Rates
You have to pay business rates if your company operates in a commercial property like offices, retail stores, and warehouses.
If you run your business at home, you generally won’t have to pay business rates unless you meet the following conditions:
- Customers visit your home to buy your goods or services
- Employed staff come to work at your home
- Your home has been significantly modified for business operations
- Your property is both commercial and domestic
Your local council determines your business rates through the Valuation Office Agency’s valuation of your property.
Speak to Your Accountant
These taxes can understandably be overwhelming and confusing for small business owners, especially if you’re only starting out. Make sure you stay compliant with government requirements and that you don’t get caught on a tax you didn’t know about by talking to one of our professional accountants today.