Newly self employed client asked me to put together his P&L and do his 2011 Tax Return. He first emailed me back in April asking for info via my website then he went quiet until he contacted me again at the end of last month. Long story short he worked self employed on commission only sales for a branded blind company. He had no stock to buy / sell and just billed for a percentage of the sales he made during the year. He had 'sales' of over £25k for the 9 months.
Anyway I sent him his return to check over before I submitted it and he emailed back saying he was 'shocked' at the amount due as he only expected to pay about £1000. He said his 'mate down the pub was a driving instructor, earned about the same as him and only paid about £800 tax".
I have a bit of sympathy with him as I think Payments on Account really catch newly self employed people out, though there are more issues than that here.
I sent him an email which I have copied in for you all to peruse below - he has since gone silent and I have heard nothing for a week.
Interested in peoples feedback of this situation, how I have handled it, and what I should do next........
Copy of email sent replying to his 'shock':
Your driving instructor friend earned £22,000, take off his personal allowance of £6,475 leaves Gross Pay of £15,525. To pay tax of around £800 he would then have needed costs or expenses in his business of £11,525 your costs are just over £8k, but its not a huge stretch to that if he had more mileage, advertising, leaflet drops etc.
Problem you have is that you earned gross £33,000 for the year £10,000 more than him, because of your initial employed income. You have to pay tax at 20% on everything above £6,475 and National Insurance at 8% on any Net Profit above £5,715.
If your Tax bill is over £1,000 then you have to pay Tax in advance for the following year. If your tax bill was £5000 for year ended 2011 then HMRC presume it will be the same again for 2012 so ask for it in advance with half due on the 31st January 2012, and the other half due on the 31st July 2012. When you do your 2012 tax return, if the bill was less than £5,000 then they would refund you the difference, if more then you pay the difference. Im sorry the adverts say tax does not have to be taxing but Im afraid it is.............
So your Tax bill is looking like this:
Income from Employment £7,754 Net Profit from self employment £17,515 TOTAL £25,269
minus Personal Allowance (£6,475)
= Income on which Tax is due £18,794 @20% = £3,758.80
plus Class 4 NI Contributions at 8% on £11,800 = £944.00
= Tax and NI due of £4,702.80
minus Tax already paid in employment (£1,119.00)
= TAX AND CLASS 4 NI DUE FOR TAX YEAR 2011 = £3,583.80
Then the nasty bit Payments on Account So you owe £3,583.80 on 31st January 2012, PLUS half this figure £1,791.90 so your payment due is £5375.70, then a further £1,791.90 on the 31st July 2012.
If the client believes that they will earn less next year than this then they could apply for a reduced payment on account.
There is also the option of looking at incorporating but that of course brings a different set of issues and possibly increased N.I. (whole different dividends vs salary thread buried in that line!).
Also, considering that the client disappears off the face of the planet every time that they've spoken with you combined with the credence that they give to the man down the pub above a trained and experienced professional it's probably not even worth your time and effort trying to manage their tax affairs for them in anything beyond the current requirement of doing what they want correctly (rather than doing a more fundamental review of their business model).
Good luck with this client. Sure that next step will be them telling you that their mate down the pub only pays 50% of your fee's for his accountant! (lol).
__________________
Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
Great reply, it's a horrible job explaining Payments on Accounts to clients and one I dread, although i've only done so a handful of times.
I don't envy you Ken, but you've explained it very well and I can only guess that between your client and his mate(s) down the pub that they don't know what to do next - as it's correct.
Ken - I also think this is a very good reply but I would recommend putting the numbers in an attachment. It is too much detail for the email/letter.
I would also explain that you could look at reducing the payment on account and help negotiate a payment plan. But, I would also use the explain about getting advice early and introduce the idea of paying less tax by using a Ltd Co.
You're email is great and to the point. The first year is the hardest with new clients and nobody wants to lose one that you've just turned round in a month. Try saying 'two years tax becomes due in 6 months', and give him an estimate of January 2012. best wishes
@bob - I normally attach a nicely formatted 'tax calculation' summary created in Excel, then sent in pdf to the client. As those figures hadn't been finalised (which I pointed out later in the email) I just bashed them out in the body of the mail to reply to his query.
@shaun - good thinking, and I have suggested it, though also pointed out the risk with potential penalties should he still end up owing the same amount in 2012.
@spamkebab I wouldn't be surprised, which will then take me down an ethical dilemma which I'll leave until another day.......
@don - good way of explaining it, though it won't help him like Mr HMRC
@shaun, Ben, bob - cheers, you may be right about my fee, though I've got his paperwork I know our legal right to lien only extends to my workings, as keeping his papers could be classed as theft, believe it or not - another discussion?....
I'm not sure how the same scenario would have resulted in an overall less tax take/cost had he been limited, at this level my calculations always seem to end up the same whether sole trader or ltd....I know he could have saved the NI, but CT was 1% higher last year and he then would have extra compliance fees ..perhaps someone more qualified than me can help me with some numbers around this......
Sorry to have gone on, but I could have done this for him back in April, and he would have had ten months to save up the tax.......I just don't understand why people leave them until the last minute, though I guess the organised ones wouldn't need us so much.......
Is the driving instructor LTD and had he already paid POA? If yes to either of those questions then, obviously, the comparison your client makes is irrelevent.
The employment seems to have been taxed on a normal 647 code, so that can be removed from the equation.
Your client's £1000 estimate works out at a rate of 5.7% of profits. Ask him 'what proportion he saving up for tax?' This reminds me, I must tell a new one to save a quarter of his estimate profits. Was there any redundancy pay?
He can try asking for time to pay on the Business Payment Support Line.
He was trading, what 15 months before he brought his bumph to you. It's possible he hadn't saved a penny up till then and in any case it was too late to be Ltd for this SA Return.
I appreciate the figures were not 100% but I would still keep them out of the email/letter.
On reflection I would have set it out like this;
Dear client,
I can understand your shock and confusion, tax is not a simple topic.
There are two reasons for the difference between your friend's tax and yours:
Reason 1 - you earned £10,000 more
You had employment income and self-employment income in the year which totalled £33,000. Your friend only had one source of income which was £22,000
Your employment income used some of your tax free allowance and lower rates of tax. This meant you had a higher rate of tax and less allowances to set against your self-employed income compared to your friend.
Reason 2 - payments on account
If your tax bill is over £1,000 for the year you have to pay tax in advance for the following year.
So, not all of the tax bill relates to the year.
What next?
I attach my calculations and will call you to run through them because I believe it is very important you fully understand your tax position.
Based on the levels of profits you have there is a tax planning strategy you may be able to take advantage of. I will explain this when we speak.
I've had some great feedback here and am always looking to gain knowledge from every angle to further my business........which is ironic as a previous employer always said publicly that I took feedback about as well as "....insert your most hated political dictator of all time here..."
Then again I was always right. Amazing the difference when one works for oneself.
Keep meaning to thank him for sending me down the self employment route, should have done it years ago.
I may be missing something but did he pay a higher (or lower) rate of tax I think the 33K was gross income? *
The allowances would have been used anyway had he been S/E from the start of the year. It is true, therefore to say he had less allowances but only in proportion to the 9 months trading.
If he was employed for 3/4 months then the tax paid on the employment settled the employment earnings.
best regards, Tim
* EDIT confused
-- Edited by Don Tax on Tuesday 29th of November 2011 09:27:02 AM
Total (Gross) income for 2010 - 2011 = £33,000 therefore all taxed at lower rate (20%), in this example empolyed or self employed income would make no difference, it was the fact he had £10k more gross and less expenses that made the difference IMHO
- could Bob have meant the friend not paying NI if below the net profit de minimis?
Whatever the issue/answer the point I am making is "how" it is explained - it's the layout and lack of detail/numbers in the email/letter I am suggesting.
But, having PAYE income in the same year means there is less personal allowances and 10% rate band to use against the self-employment income. The friend has all of this.
Bob, if you bring in the loss of allowances then bring in that he'd paid tax too. Looks like he paid 20% which cancels the allowances loss.
It's only been a week, Ken but if he quibbles, you're reporting on the period before he telephoned. Throw it back at him with "how much did you save up?".
Nothing - Shrug and quote Benjamin Franklin.
say 10% - The 'real' rate of tax/nic is 20.5 but as he'll have been saving for 19 months he might be approaching enough for 10/11 so he should send as much as he's got.
@Tim - sorry, I don't understand you because the comparison is the tax on the self-employment income. If some personal allowances have been used elsewhere the tax will be higher for one than the other.
Yes we're comparing the tax on the 2 self employment incomes.
There are less allowances but you'd expect that because there's less of a year. The point is, the client earned more in 9 months than the instructor did in a full year. I'm assuming the driving instructor friend didn't start part way through too. The 10p savings rate doesn't come in to it.
The employment income can be disregarded as it seems to have been taxed correctly at 20% and 3/12 of his personal allowance used.
Tim - that's the half of the story the client is interested in. He knows tax has been paid on his employment income, he wants to understand why he is paying more tax on his self-employment income compared to his friend which is roughly the same.
Bob, I was concentrating on profits working on the lines that 'Gross Pay' in this example indicates profits of £10.5K.
Your driving instructor friend earned £22,000, take off his personal allowance of £6,475 leaves Gross Pay of £15,525. To pay tax of around £800 he would then have needed costs or expenses in his business of £11,525
Yes, the friends £800 tax bill is conveniently in the ball-park of what the client thought he should pay.
I recently came across a surprising ignorance of tax from a highly educated school-friend, but in this case my suggestions were in the (perhaps forlorn) hope that the client would realise saving 5.7% or 10% for tax was naivety.
Amazing the difference when one works for oneself. 
