Anger over referrals cap
Recent pay rises mean next year most GPs will face a hefty tax bill. Dr John Couch says you need to prepare now
It is no secret that GP principal income levels have jumped during the 2004/5 financial year, after many years of stagnating. Most practices have been able to increase drawings. However, because principals fall under the schedule D taxation system, the effects of a pay hike on income tax are not felt until the following year. With the vast majority paying tax in the 40 per cent band, January 2006 is going to bring a very nasty surprise.
There has been a combination of factors allowing incomes to rise the new GMS contract, especially combined with the quality framework; a small increase in private income; and many partnerships have reorganised as partners leave, replacing those partners with salaried GPs and nurse practitioners.
Schedule D tax
As most principals are aware, we are classed as self-employed businesses. Our profits for each year are not accurately known until the accounts are drawn up, usually several months after the tax year end. Tax is paid at the end of January and July in this following tax year and is made up of two elements. A payment on account is made for the current year based on the previous year's profit figures. This is divided into two equal instalments. A balancing payment is also calculated based on the amount of tax that should have been paid for the previous year less the total actually paid in that year. In the event of a fall in profits (or if a GP retires part-way through the financial year), the balancing payment can actually be a rebate.
It is easier to understand if you consider a new business starting up from April 1, 2003. No tax is paid during 2003/4. Once the accounts for this year are finalised during 2004/5 the tax figure can be calculated. If the tax is £30,000 then £15,000 is paid by January 31 and July 31 2005 as payments on account.
Once the 2004/5 accounts are finalised during 2005/6 the tax figure that should have been paid can be calculated. Assuming a rise in profits, the balancing figure for 2004/5 will become payable at the end of January 2006. If £35,000 should have been paid, then the balancing figure will be £5,000.
Next comes the double whammy as the payments on account due in January and July 2006 will also be increased to £17,500 (£35,000 divided by 2). Therefore at the end of January 2006 £22,500 (£5,000 + £17,500) must be paid.
Class 4 national insurance
Class 4 national insurance, which is paid at the same time as income tax, brings a triple whammy. This is paid at 8 per cent of taxable profits between £4,895 and £32,760 (2005/6) and then 1 per cent thereafter. Class 4 used to be capped at this upper limit but the Chancellor added this latter payment a couple of years ago.
The January 2006 payment
In a year where incomes have jumped, the Inland Revenue gets its payback the following year. This is exactly what is now affecting GP principals, who face a 41 per cent bill for their increase in taxable profit for 2004/5. Unless we all make extra provision now, our personal cash flow in January is going to be severely compromised. For the average GP the triple whammy effect is going to be well into five figures. The exact amount will not be known until your accountant has processed your 2004/5 accounts.
For practices with a March 31 year end, financial records should now be with their accountants. If not they must move this forward at once. Practices with later year ends should plan for a very early accountant visit. Assuming your records are with the accountant you should ask them to prioritise the processing and produce draft accounts quickly. You can very roughly estimate your extra tax bill using figures from 2004/5 (see box above).
GPs with other major factors affecting tax in 2004/5 (such as a large business loans or pension contributions) will either need to allow for these or check with their accountant. The final amount will overestimate as no account is taken of the 04/5 balancing superannuation payment which is tax deductible. At the time of writing no GPs have their figures for this.
The likely figure
If we assume the average GP principal taxable income has risen by around £20,000 for 04/5 then the balancing tax and class 4 insurance payable at the end of January will be £8,200. The payment on account will also rise by £4,100 in January 06 (and again in July). The total increase for January would be £12,300 and for the year £16,400. Many will face higher amounts.
Whether you save for tax personally or through a practice tax account, the amount should be increased now. In the example given above, an extra monthly payment of £2,050 for six months and then £340 (to cover the extra July payment) should be made. Alternatively, if you only increased drawings by a conservative amount, as many accountants advised last year, there should be a healthy partner's current account balance once accounts are ready. This could be used to pay some of the extra tax. The same applies if you withheld a reasonable amount of QOF income to cover the NHS superannuation balancing payment due later this year and overestimated.
Finally, do not forget that principals face another income jump this year due to year two QOF increases. Tax payments for January 2007 will reflect this.
Pay rises are always welcome but the tax consequences are definitely not!
John Couch is a GP in Ashford, Middlesex
Nine steps to estimate your extra tax bill
your extra tax bill
Use figures from your
1. Extract the practice net profit figure (practice income minus practice expenditure)
2. Deduct your prior shares (seniority, rent reimbursement etc)
3. Calculate your own profit share of pooled income from the sharing ratios for 2004/5
4. Add the amounts from steps 2 and 3 to get your individual profit share
5. Deduct the similar figure for 2003/4 to get the increase in practice profit share
6. Calculate any increase in profits for any income you earn outside the practice
7. Add the figures from steps
5 and 6
8. Deduct a nominal 2 per cent
from this figure for increases
in personal and business allowances (eg medical defence subscriptions)
9. Multiply this final figure by
41 per cent