Limited companies have typically yielded tax savings for businesses in the past, no matter the level of profits generated by the business.
However, in the last couple of years, there has been a rise in dividend income tax rates, followed by corporation tax rates rising for companies from 1st April 2023. The dividend tax free allowance has also reduced from 6th April 2023 from £2,000 to £1,000, and is planned to decrease again from 6th April 2024 to £500.
With companies and shareholders facing increased tax costs, should associate dentists still consider incorporation to save tax? We’ve asked Tom Slevin, Dental Client Services Director, for his thoughts, and to outline what we look for when considering whether incorporation is the right choice for a dental practice.
Over to Tom…
With many associate dentists now reducing their NHS dentistry workload or even no longer carrying out any NHS dental work, the option of trading through a limited company becomes a more attractive proposition for many associates.
We have a checklist that we go through when assessing whether incorporation is the right decision for our clients. This includes the following:
- Will the dentist be carrying out NHS dental services? If so, are they happy to stop contributing to the NHS Pension Scheme and also lose out on NHS parental pay benefits?
- Is the profit level sufficient to make the limited company worthwhile?
- How much income do they require each month for their personal living expenses?
- Does the dentist have a spouse who could be a minority shareholder in the company?
The list above isn’t exhaustive, and each dentist will be considered individually on whether incorporation is the right choice for them.
So, let’s go into more detail on the points above…
If the dentist is carrying out NHS dental treatments, trading through a limited company will make them ineligible to make NHS pension contributions from the point they start trading through the company. Independent financial advice should be sought by the dentist if they are currently contributing into the NHS pension scheme, as the loss of NHS pension benefits can be significant for those dentists who are carrying out a lot of NHS dental treatments.
When discussing this with clients, many of them are not aware of the loss of NHS parental leave benefits as well. Dentists who carry out NHS dentistry work are paid their estimated net pensionable earnings for a period of parental leave. For men, this is 2 weeks and for women, this is 26 weeks. For a female dentist who has annual net pensionable earnings of £50,000, the parental leave pay will be £25,000. Those dentists who are looking at having children in the not-so-distant future should consider this loss of benefits before proceeding with trading through a limited company.
The dentists expected profits should also be considered before incorporation. If the dentist has annual profits of less than £50,270 then the tax savings may not be worth the extra fees incurred when trading through a company and the tax planning opportunities would be restricted compared to a dentist paying income tax at the higher rate.
With the rise in corporation tax rates and dividend income tax rates, dentists with very high profits may also no longer see tax savings within the company if they require all of the post corporation tax profits from the company for their own personal expenses.
The following graph shows the effective tax rate on profits for a self-employed dentist compared to a dentist trading through a limited company who takes all available post tax profits from the company as a mix of salary and dividends (but doesn’t consider the increased accountancy costs involved with a limited company):
As you can see, the effective tax rate is higher for the dentist trading through a limited company at various profit levels under the above stated conditions. For profits over £150,000, the effective tax rate paid by the dentist on their company profits and income tax on their income from the company is higher than the effective tax rate for a self-employed dentist.
Dentists who will require all their income from the company may therefore not actually save any tax trading through a company, unless they have a spouse who has a lower level of personal income who could be a shareholder in the company.
For those dentists who do not require all of their post-tax income for their personal living expenses, a company offers more planning opportunities and control over their personal income, and this is where a lot of dentists can save or defer tax each year.
Income required from the company
A company pays corporation tax on its profits, and the company’s post-tax profits form the retained earnings or reserves of the company. Dividends can be voted to be paid to shareholders where there are sufficient reserves for the dividend to be voted.
What is important to know is that the company does not need to pay out all of its reserves each year and the company and its directors may decide to leave reserves in the company for various reasons:
- Shareholders require less dividends for their own personal expenses.
- Company is saving a cash fund for future capital expenditure, practice purchase, property purchase etc.
- The director may be planning to temporarily reduce their working hours in the future (for example, parental leave) and is saving cash within the company so dividends can be paid to the shareholder while the company is making reduced profits.
- A dentist nearing retirement leaves cash within the company bank account and can either use this as a source of income post-retirement or with some tax planning, dissolve/liquidates the company to release the funds in the company to the shareholders.
As the shareholders are receiving less income from the company, their income tax liabilities are lower. With the marginal rate of income tax on the dividends likely being 33.75% or even 39.35% for the highest earners, there can be significant tax savings/deferral by leaving cash within the company that isn’t required by the shareholders.
For a dentist with profits over £100,000, a company can prove attractive, as the dentist can ensure their own personal income is then below £100,000. This ensures the dentist retains their personal allowance (on adjusted personal income between £100,000 and £125,270, taxpayers lose their personal allowance resulting in more of their income being taxable at tax rates up to 60%). If they also have young children, having adjusted personal income of £100,000 or less also ensures you are eligible for tax free childcare.
The company may have more shareholders than just the dentist. We commonly see the dentist’s spouse also being a shareholder in the company. If they don’t earn any other dividend income, a dividend of £1,000 can be paid to the spouse with no income tax liabilities due.
If the spouse earns less than £50,270, dividends can be paid to them to take their income up to £50,270 with the income tax rate on the dividends above £1,000 being 8.75%. If those dividends were to be paid to the dentist, the income tax rate could be 33.75% or 39.35% and so there is a significant reduction in tax liabilities.
If the dentist’s spouse earns above £50,270, there may still be some tax savings with voting dividends to them instead of the dentist as described above where the dentist would otherwise have income above £100,000 and start to lose their personal allowance.
Not a one size fits all solution
Each dentist will have different personal circumstances and needs, so a limited company may be the best option for one dentist, but the wrong option for another. At DJH Mitten Clarke, we consider each dentist’s own circumstances and requirements and can give you bespoke guidance on whether a limited company is the right trading structure for your business. This will factor in all of the above questions and more to ensure you are making the right decision.
If you are considering incorporating your associate dentist business but unsure where to start, one of our specialist team can look at all aspects of the incorporation for you.
To speak to our team on how we can assist, give us a call on 0151 348 8400.