Easing the pain of your tax bill

Many consultants complain how painful their tax bill is. But they can often get relief if they are prepared to do something about it. Willie MacKenzie gives some practical examples

Hospital doctors spend a large proportion of their working lives relieving the pain and discomfort of their patients.

But while doing this, they often neglect their own tax problems and end up with pain of a different kind.

I recently went to see a consultant surgeon to discuss his tax problems. He was concerned that the tax bill on his private practice had been rising even though his earnings had reached a plateau.

The agony generated by the tax bill was magnified by this dilemma - he wanted to reduce the quantum of tax he was paying but did not want any hassle, so he rejected any complicated tax-saving measures, or red-rag tax schemes that might annoy the Inland Revenue.

The trouble was that he considered any action which required changing the status quo to be too complicated.
The source of his tax pain could be diagnosed as a lack of elementary tax planning. But he did not consider the remedy palatable.

Tax planning invariably requires you to do something differently.

Partnership

The consultant had ignored the maxim 'partners in life, partners in business'. Even though he had a wife and two adult children - one of who was at medical school - his sole tax planning measure consisted of paying his wife a salary at the level of the current personal allowance of £4,745.

He hadn't considered bringing in other members of his household as business partners so they could earn income up to the higher rate threshold (currently £31,400) and reduce the total amount of tax the household was paying.

What I suggested was to trade as a partnership as opposed to a sole trader. It is far easier to justify paying a spouse or relative a significant amount as a partnership profit share than it is to pay the same amount as a salary.

This is because a salary is a deduction in arriving at the profit and therefore has to meet strict tax rules. No such restriction applies to partnership profit shares, although there are anti-avoidance rules that can negate the diversion of income to family members.

However, partnerships should come with a profit warning. All partners are jointly liable for the partnership's debts. Anyone who has obtained a judgment against one or more of the partners in respect of a partnership debt can later take action against another partner or partners in respect of the same debt.

Also, a word of warning on divorce - most judges will split the partnership assets and income down the middle if both spouses are partners. Remember that one in three marriages ends in divorce and this statistic may be higher for hospital consultants.

Incorporation

If your practice is making reasonable profits, which are being re-invested in the practice, you may be able to substantially reduce the tax you are paying by trading as a limited company.

A company pays tax at 19 per cent on profits up to £300,000, whereas for an individual this is 40 per cent on profits above £36,000.

To reduce the tax burden further, members of the family can own shares in the company and receive dividends in respect of these shares. If the family members have no other income, they each can receive dividends worth nearly £32,000 with no further tax to pay.

This simple expedient of paying dividends to several family members can save tax and National Insurance of many thousands of pounds.

I should, however, add several notes of caution. It is very easy to present a case for incorporation by looking at the tax advantages but there are a host of non-taxation matters that need to be considered.

• Running a company as opposed to a sole practice involves an increased compliance burden and resultant red tape;
  
• A strict distinction must be made between the company's money on the one hand and the directors' or shareholders' funds on the other hand;
  
• If your children are under 18, then paying them dividends to save tax will not work, as all income paid to the child or for the child's benefit will be deemed to be that of the parents.

If you plan to have your spouse hold shares in your company, then ask them to subscribe for ordinary shares in their own name using their own funds, not money you have given to them.

Using family members to help reduce your tax bill though a partnership or company does involve risks.

If you don't get the documentation right and do things in the wrong order, you could end up with a nasty shock of additional tax liability. So seek professional advice.

As a post script to my story, I never heard from the consultant again.

Presumably, he just wasn't experiencing enough pain. I would guess this would be because he was too busy earning enough money to pay the next tax bill.

Mr MacKenzie is a chartered accountant specialising in the tax affairs of consultants. Contact him by phone on 01483 419922, by email at wtm@accmac.plus.com or visit www.wesaveutax.co.uk