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  • Tax

    Paying less tax in a company (part 2)

    Part 1 clearly demonstrates that if Joe reinvests all his rental profits he will be significantly better off using a company when it comes to saving Income Tax.

    I now turn my attention to what happens if Joe withdraws all of the money from the company as income.

    I previously ascertained in part 1 that If Joe uses a company it will pay £14,450 Corporation Tax on its £85,000 rental profit. This leaves a £70,550 after-tax profit (85,000 - 14,450). I’m now going to assume that Joe extracts the whole £70,550 as a dividend. If I add this to his £50,000 salary (from another job not related to property) this will give him a total taxable income of £120,550 (50,000 + 70,550 = 120,550).
    Unfortunately Joe starts to lose his personal allowance once his income goes over £100,000.

    As his total taxable income is £120,550 his personal allowance will be reduced from £12,500 to £2,225 because he has gone over the £100,000 limit by £20,550 (120,550 - 100,000 = 20,550). For every £2 of taxable income over £100,000 he loses £1 of the £12,500 personal allowance. £20,550 equates to a loss of £10,275 of personal allowance (20,550 divided by 2 = 10,275).

    So only £2,225 of his £50,000 salary income will be tax free (12,500 - 10,275 = 2,225). The next £37,500 of his salary will be taxed at 20% (37,500 x 20% = 7,500).

    The final £10,275 that makes up his £50,000 salary will be taxed at 40% (10,275 x 40% = 4,110). So a total of £11,610 Income Tax will be due on his £50,000 salary (7,500 + 4,110 = 11,610).
    Turning to his dividend income of £70,550 - the first £2,000 will be tax free thanks to the dividend allowance and the remaining £68,550 (70,550 - 2,000 = 68,550) will be taxed at 32.5% giving an Income Tax bill of £22,279 (68,550 x 32.5% = 22,279).
    So Joe’s total Income Tax bill will be £33,889 (11,610 from his 50,000 salary + 22,279 from his dividend income = 33,889) which means he’ll be left with an after-tax income of £86,661 (£50,000 salary + £70,550 dividend - £33,889 tax = £86,661).
    How does this compare with owning the properties personally?

    In the example in part 1 Joe had a net rental income of £125,000 after deducting all costs except mortgage interest of £40,000 per year. So his ‘true’ rental profit is £85,000 (125,000 - 40,000 = 85,000).

    As we saw in the example in part 1, Joe would face an Income Tax bill of £55,750 in personal names. This means he would be left with an after-tax income of £79,250 (50,000 salary + 85,000 ‘true’ rental profit - 55,750 tax = 79,250).
    So in a company Joe is left with £86,661 after-tax income and £79,250 in personal names. Therefore Joe is better off to the tune of £7,411 (86,661 - 79,250 = 7,411).
    I have have ignored the National Insurance on Joe’s salary throughout this example to keep the calculations as simple as possible. This has no effect on his final overall saving as his National Insurance cost remains the same under both scenarios.
    There you have it. Conclusive proof that under certain circumstances it is possible to pull out money from a company in a more tax efficient manner than in personal names. I could have improved the company situation further if Joe had taken a small salary equal to the National Insurance threshold before taking a dividend. However I didn’t want to make it too easy for myself and the calculations would have been more complex and harder to follow.
    Disclaimer: Not all personal versus company calculations will produce a favourable outcome for the company investor so it is essential that you do your own calculations to determine the potential Income Tax savings. Hopefully you are now freed from the groupthink that personal is always better than a company for income extraction.
    Phew! That was hard work. Hopefully I’ve worked out my calculations properly and you can all follow what I’ve written. I invite the tax experts out there to check my figures and confirm my analysis is correct. Rest assured if I’ve got it wrong I will issue an immediate abject apology.
    Sorted.
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    Joe great bit of work, one thing I would say is that in the company structure you also have the flexibility to only take some dividends, put some into a pension or add additional shareholders to spread the dividends and thus tax bill.
    In my view the company route offers a flexibility that you dont get from holding property in a personal name
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    Slowly working towards financial freedom


    All good points. Limited companies have a lot going for them in the right circumstances. That said, it’s not the right solution for everyone.
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    Thank you very much. Really well explained. 

    However I think this works if starting from scratch but if you were to convert from personal to company and require an income then The costs involved in doing so would make it the wrong decision wouldn’t it?
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    It depends. This is the only honest answer I can give. Each person’s circumstances are different. I’m not advocating that all landlords should form companies and transfer properties into it. 

    For example if you were a basic rate taxpayer I would generally always advise you to stay in personal names. 

    Far more needs to be understood about your own circumstances before advice could be given as to whether a company would be right for you.
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    For example if you were a basic rate taxpayer I would generally always advise you to stay in personal names.

    As an incorporated basic rate tax payer I feel obliged to challenge that generalisation. As you have stated "Each person's circumstances are different" 

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    A good teacher must know the rules; a good pupil, the exceptions.

    Martin H. Fischer


    That's why I said 'generally'. I didn't say I would always advise to stay in personal names. So not guilty of a generalisation. I am intrigued though to know why you have incorporated.

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    As it happens I recently created a post here:

    https://www.propertytribes.com/what-prom...41772.html

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    A good teacher must know the rules; a good pupil, the exceptions.

    Martin H. Fischer

    You had a very complex set of circumstances. I would still maintain that for landlords with relatively straightforward circumstances, incorporation is generally not a good idea.

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    To substantiate my belief with a simplified version of my own circumstances I'll take an employee earning £20k with £200k to invest and exploring the options of giving up the day job. They have found a property for £200k with a net yield of £20k and question how to purchase it.

    As an employee earning £20k, they are used to paying £1500 IT and £1364 NI, leaving £17,136 take home pay.

    As a Sole Trader they will simply pay IT of £1500, leaving an income of £18,500.

    If they incorporate and use the Savings Allowance and Starting Rate For Savings on a directors loan they can receive £18,500 free of IT or CT. They can also receive a further £2k free of IT. As there is only £20k available, the £1500 profit would be subject to £255 CT, leaving the director with an income of £19,745.

    This wasn't my deciding factor. I wanted to share this investment with my daughter. If I had bought in our joint names this would have not only removed her FTB status, it would have had an adverse effect on her student loan and any future income benefits should she need them. By incorporating there is no adverse effect (at least on FTB and student loan, I've not checked benefits) and she can enjoy up to £2k pa tax free in dividends without the need for SA.

    What really influenced me is that by paying down the directors loan from retained profits I can manipulate my net worth as I get older. I'm not overly concerned with IHT as my liability will be small but I've received qualified advise that I've probably done enough to avoid it (confirmation of this advice would have cost more and didn't seem essential). What I believe to be the greater threat is the loss of assets for care needs later in life which can be manipulated in a company format without falling foul of deprivation of assets legislation. Its far more difficult for assets owned directly.

    My ultimate aim upon retiring is to hand directorship to my daughter and buy a lifetime lease from the company with the outstanding balance of the directors loan, but I'm not sure if this is actually possible/allowable. I'll take further advice as the time approaches and legislation becomes amended.

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    A good teacher must know the rules; a good pupil, the exceptions.

    Martin H. Fischer


    As an old Landlord who is a 40% tax payer

    I know I just pay more tax than I would when I invest  in my own name

    Since Osborne changes

    I see a Company structure  as the only way forward and I try and take advantages of the Pluses

    Sucsession Paying my wife 8k a year and Pension Planning of course

    Buying more property is more costly than it was in my own name

    and accoutancy and running costs are more

    NO GGT allowance when you sell costs of running a pay roll

    and there is also a the fact that the world can see what you own and your wealth is in display at the press of a button

    I have nothing to hide But If I invest in my own name every tom dick and harry cant look at my accounts

    BTL is now a Business Not an investment

    Tom Dick and Harry cant look at my pension ISA or my BTL in my name which is ok with me




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    Learn Change and Adapt ?????

    All comments are for casual information purposes only. If you wish to rely on any advice I have given please ensure you obtain independent specialist advice from a third party. No liability is accepted for comments made.