Do thoughts of your tax return keep you up at night?

We’ve all worried about our tax return. Whether you have an accountant or are completing self-assessment on your own, you will have wondered about how best to handle your business finances.

With the self-assessment deadline looming, we asked Emma James, aka The Number Ninja to answer questions from Drive members.

Emma JamesEmma provides remote bookkeeping and accountancy services to micro businesses and much, much more. She is also an app ninja and streamlines processes to make businesses run smoothly.

This is a transcript of a discussion in the Drive The Network Facebook Group.

Andrea Joyce Is there an easy way to know in advance what your tax bill is likely to be so you can keep that money to one side?

Emma James Keep on top of your bookkeeping throughout the year. That way you can get a good sense of what your profit is at any point and then work out your tax liability based on that. Alternatively, HMRC have a simple ready reckoner where you can enter your estimated weekly or monthly profit and it will estimate your tax – https://www.gov.uk/self-assessment-ready-reckoner

Ideally you’d be saving towards your tax bill throughout the year, as you really want to be paying for this year’s tax out of this year’s cash-flow. As a *really* rough idea, putting aside 30% of your earnings is a good place to start. It very much depends on whether you’re also employed, what your income level is, and what level of expenses you have, but it’s a good starting point.

When should you get an accountant?

Charlie Hart At what point does having an accountant make sense? My income and expenses are relatively easy to keep track of, but I feel I’m leaving money on the (taxman’s) table and wonder if I should be claim for more expenses.

Emma James If your affairs are simple, then you’re probably okay on your own, but once you start adding complexity then it pays to work with an accountant. Knowing what you can and can’t claim for is hugely important. HMRC have lots of advice on this, though it is written in a rather dry way and can be a bit hard to understand at times.

Andy Boothman Whether it’s an accountant or someone like Emma who knows the systems, outsourcing this stuff saves you time that you’re better off spending on the other bits of the business that make you the money in the first place, regardless of where you sit with the tax issues. Just saying!

What is making tax digital?

Helen Lindop I keep reading that tax returns will be changing in that we’ll need to keep our records electronically and submit tax returns 4 times a year, BUT there’s a threshold so it may not apply to many small businesses. I can’t for the life of me find any official info on it at the moment so could you help please? I wonder how much of what I’ve read so far has been GDPR-style doom mongering.

Emma James It’s part of something called Making Tax Digital. It’s being phased in and the first phase starts in April 2019 and is for businesses that are both VAT-registered AND over the VAT threshold, so not those who voluntarily registered. All returns will have to be made electronically.

It’s due to include other businesses from 2020, but it’s already been watered down a lot so I wouldn’t worry too much about it at the minute. I would, however, consider making the move to keeping your records electronically and up to date, if you don’t already.

How do you keep your financial records?

Andy Boothman Any tips for best ways to keep your records safe etc Emma? I believe it’s still 6 years afterwards that you need to have them readily accessible – which if you’re fully digital is more easily managed. Any tips on both?

Emma James I’d always recommend storing things electronically, partly because it’s easier than finding space for 6 years worth of lever arch files, but also because it’s easier to find what you need it if you’re ever investigated by HMRC.

If you REALLY want to store paper, invest in storage that protects the paper. It’s not much use keeping that fuel receipt from 5 years ago if the ink has disappeared by the time you need it.

Andy Boothman I find receipt bank useful for the smaller out of pocket stuff where I still have physical copies.

Emma James Also, depending on the accounts software you’re using, you can normally store documents in the software against the actual item, which makes it really easy to find things. And also makes your bookkeeper very happy if they have a query and don’t have to rifle through 67589 receipts to find it.

Helen Lindop Can I safely shred receipts etc if I have an electronic copy? Or is it best to hang on to them just in case?

Emma James Up to you. HMRC say that you just need to keep a copy, and electronic is fine. I have mine in both Xero and stored in Tresorit, I shred all of the paper copies.

Ann Hawkins Do you know the percentage of small business that DO get investigated Emma (looking to allay some fears!)

Emma James I can’t find any firm figures, but it’ll be small. For example HMRC were aiming for 1,165 prosecutions in 2014-15. So the total number of investigations will have been much higher than that, but still small when you consider the total pool.

Daljit Virdee Just to add that many investigations are triggered by things that HMRC notice on returns which don’t add-up (I don’t mean literally arithmetically). They often have 3rd party information to corroborate tax returns, and are working on enhancing that capability. MTD will help them with that. An example is HMRC getting returns from Estate agents showing how much rent they’ve had in for their landlords.

Cash basis or accruals?

Rachel Extance What’s the difference between cash and accruals?

Emma James They’re two different accounting methods. The cash basis looks at when the money physically enters or leaves the business. The accruals basis means that you account for something in the period it is incurred or when you get the benefit, regardless of when the actual money comes in.

So say you send a sales invoice for £100 to a client dated 1st March 2018 and they pay 20th April 2018. If you’re using the cash basis then the £100 is included in your tax return for 2018-19, as that’s when you received the money. But if you’re using accruals (also known as traditional accounting) then you’d include it in the 2017-18 return as that’s when you did the work.

In theory the cash basis makes it easier for record keeping.

What happens to unpaid invoices?

Ann Hawkins What if an invoice has been issued and the client never pays it?

Emma James You can write it off in a future return. But you can only write it off if you’re as sure as you can be that you won’t be paid.

Rachel Extance So that would apply if you did accruals basis? If you are doing cash presumably you don’t have to declare it until the money comes in.

Emma James That’s correct, yes.

Rachel Extance Is that an argument for working on a cash basis rather than accruals so you don’t end up paying tax on money you haven’t seen yet? Is there a point at which you have to do accruals?

Emma James If you’re a sole trader and your turnover (sales) is under £150,000 then you can use cash. If you’re using the cash basis and you buy a computer, you’d have to claim the full amount of this in the year you bought it, rather than spreading it across the life of the computer as you would if you used the accruals basis. There are pros and cons to both. I prefer the accruals basis as it’s how accounts need to be prepared for banks and potential investors, but cash is better for some businesses, particularly if they’re not paid particularly quickly by customers.

What are common mistakes people make on self-assessment?

Rachel Extance What are the things people often trip up on?

Emma James Not tracking gift aid payments is very common. Not a lot of people realise that they can claim for working from home. Quite a few people don’t realise that if you’re a sole trader you’re taxed on your profit, not just what you take out of the business, that catches a few people out. Food is another huge one, just because you’re working when you buy that sandwich at Costa it doesn’t mean it’s tax deductible.

Payments on account really trips people up in the first year it applies to them. It’s a little complicated to explain, so I’ll link to a blog I wrote a while ago https://thenumberninja.co.uk/blog/payments-on-account/

Savings interest is another one that people often leave off. For the majority of people it’s not going to make any difference to the amount of tax you pay, but it still needs to go on the form (unless it’s an ISA, in which case it doesn’t).

Rachel Extance Can you explain a bit more about this one: “Quite a few people don’t realise that if you’re a sole trader you’re taxed on your profit, not just what you take out of the business.” Thanks.

Emma James Okay. Fred is a sole trader (rather than a limited company) and has sales of £40,000. His expenses throughout the year, such as rent, software, etc. come to £10,000. This gives him a profit of £30,000. Fred has taken out £1,000 a month for his personal use, so £12,000 across the year (lots of people consider this to be their salary, but as a sole trader they’re known as drawings).

As he’s only taken £12,000 from the business, Fred might think that’s what he’s taxed on, as that’s his income from the business. But as a sole trader there’s no legal distinction between you and the business, they’re one and the same. As a result the £30,000 profit is considered to be Fred’s total income.

So Fred’s personal tax would be calculated on the £30,000 profit, rather than the £12,000 drawings.

Rachel Extance Do you put on the form what you have drawn down from the business as a sole trader?

Emma James No, HMRC don’t care. They’re only interested in the profit you’ve made. All of the money is yours, you’ve just chosen to leave some of it in a separate pot.

Keep a regular check on your accounts

Emma James Completing your tax return is a damn sight easier if you’re regularly keeping on top of your bookkeeping throughout the year. I’m a huge fan of using accounts software, but a spreadsheet is also fine. Keep that up to date each month and then you’ll have all of the information you need for the return itself.

The rules do change from time to time as well, so even if you’ve been completing a self assessment return for years, read the notes before you dive in. For example the rules of claiming mortgage interest if you let out property have changed in the last few years, and something called the trading allowance was introduced for the 2017-18 tax year that has slightly confusing rules that could catch some people out.

Rachel Extance What do we need to put on our spreadsheet? Is there a list of must-have headings? (I presume something more than money in, money out)

Emma James It depends what you want to be able to get out of the spreadsheet. If you’re only using it to help you prepare your tax return then I’d include the expense categories that HMRC use (so ‘Cost of goods bought for resale or goods user’, ‘Phone, fax, stationery and other office costs’, etc.). That way you can then write formulae to total those costs together and then just pop the total in the form. Date is a good one to have, as is a column for the next tax year if you’re using the accruals basis, so if you’ve got an invoice for your business insurance for £100 that covers Oct18-Sep19 you can make a note that £50 needs to go in your 18-19 return and £50 in your 19-20 return (if you’re using the cash basis then the full £100 would go in 18-19).

I love a chart, so my spreadsheets are a bit ridiculous and show me what my sales and expenses look like throughout the year, so I can use it to predict any trends for next year. I also have an estimate of my likely tax liability throughout the year so that I can make sure I’m saving enough.

Rachel Extance What’s the trading allowance?

Emma James The allowance is £1,000 and in part is designed to remove the need for hobbyists to declare their income. So if you car boots once a month and you’re total income from that is less than £1,000 then you no longer need to complete a self assessment.

Anyone who’s self employed can use it if their income is more than £1,000. You then just deduct the £1,000 allowance from your turnover, but if you use it you can’t then claim for any of your expenses. It’s not likely to be of any use to anyone in Drive.

HMRC want you to get it right

Emma James I hope it’s been useful. The UK tax system is one of the most complicated in the world, but good planning and preparation can make a huge difference. Get all of your information together, read the notes, and take it slowly. Although it might not feel like it at times, HMRC want you to get it right, so if you’re not sure about something, check their website for help https://www.gov.uk/topic/personal-tax/self-assessment.

Would you like to know more? Contact Emma James at The Number Ninja or follow her on Twitter @emmatnn