Beware of taxman’s double whammy
If you’re not prepared, the taxman may deliver a nasty surprise. Jon Drysdale explains how to avoid unpleasant shocks
For many dentists, January is a painful month as it represents one of two pinch points in the tax calendar, the other being in July. January is probably worst as it offers HMRC the opportunity to mop up any underpaid tax from the previous tax year. This is called a balancing payment and may come as a nasty shock if you haven’t been advised adequately or sufficiently well in advance by your accountant (because you waited until the last minute to provide the relevant financial information).
Being self-employed, you must make payments on account based on 50 per cent of your previous year’s tax bill. If this was higher than your current year’s tax bill, the payment on account will be higher. Hence the potential double whammy of balancing payment and payment on account.
How it works
Table 1 shows a situation where the tax bill increased by £20,000 from one year to the next and the knock-on effect on the twice-yearly tax payments. The payments in red are highlighted because they are above the norm. The increase in tax from one year to the next means an additional £30,000 is required in January 2018 (£20,000 for the balancing payment and £10,000 for the extra payment on account) and a further additional £10,000 is due in July (again for the extra payment on account). This is in addition to the pattern of amounts in previous years – resulting in a total tax charge payable in 2018 of £80,000.
To avoid nasty surprises, you can calculate balancing payments and payments on account – and do so earlier than you might think. For example, for the tax year 2017/18 this could be calculated as soon as 6 April 2018. While it may not be fair to expect your accountant to work out the figures immediately after the financial year, it does make sense to push for an early completion of your accounts and tax return. This is especially so if you have seen an uplift to turnover (therefore usually an increase to your taxable income). Company directors need to think carefully about the timing of dividend payments and discuss a remuneration strategy with their accountant.
NHS pension may cause underpayment of tax
Dentists may have an additional tax charge to pay based on their NHS pension ‘input amounts’ in any given tax year. An ‘input amount’ is HMRC’s way of describing the value of public sector pension contributions (employer and employee). The actual amount you pay is not relevant here. The annual allowance limit on pension contributions is £40,000. The NHS input amount can easily exceed this and where the limit is exceeded there will be a tax charge.
This is because the excess is deemed to be an over claim on tax relief. Unfortunately, the input amounts aren’t available until after the end of the NHS financial year, so you can’t simply adjust your NHS contributions to manage the situation. You can, however, request your Annual Allowance Pension Saving Statement from NHS Pensions in order to see if you underpaid tax in the previous year. If your input amount exceeds £40,000 you will automatically receive the statement – don’t ignore it. If you make personal pension contributions and NHS pension contributions you should request the statement – because the combined personal pension contributions and the NHS pension input amount make take you over the £40,000 limit.
More about the annual allowance
There are further points to make in relation to the annual allowance. First, if you have taxable income over £110,000 you may lose some of your £40,000 annual pension allowance based on your adjusted income. For every £2 your adjusted income goes over £150,000, your annual allowance for that year drops by £1. There are two examples of this in Table 2.
In both examples, the total input amount exceeds the reduced annual allowance (by £30,000 and £50,000 respectively). This could result in a tax charge of £12,000 and £22,500 respectively, based on the prevailing tax rates. NHS pension members should ask themselves whether the scheme remains a viable option for retirement savings
Second, on a positive note you may be able to avoid exceeding the annual allowance by using ‘carry forward relief’. This is where unused annual allowance can be brought forward from the previous three tax years. Advice is required here to ensure the NHS pension considerations are interpreted correctly in conjunction with your tax return.
About the author
Jon Drysdale is an independent financial adviser for chartered financial planners, PFM Dental, which has offices in Edinburgh and York. Go to www.pfmdental.co.uk