Tax Implications for Setting up of Business as Sole Trader - Essay Example

X has to evaluate tax implications on the basis of inheritance tax. In the given situation, X wants to find out the tax implications of each of these alternatives and then choose the best option to invest in.

Tax Implications for Setting up of Business as Sole Trader

It is the simplest of all business structures. Setting up a business as a sole trader can be very scary because X‘s liability would be unlimited. But at the same time, rewards are also unlimited as X will have claims to the extent of profit earned by the business. Moreover, X does not have to register with the Companies House and this means that X won’t have to pay the corporate tax which X had to pay had he set up an incorporated company. Another advantage for a sole trading business is that if X is not maintaining a payroll, or paper works for the employees then red tape will be reduced greatly. But this business structure exposes X to greater risk for which X may need to cover up with an insurance policy. Thus as a sole trader, X can keep all profit after paying taxes on them according to the tax slab. For every £2 that X earns above £100,000, X will have to pay £1. Thus, if the income is too high then X’s profits may become zero. So, the tax liability of X in the case of the setup of the business as a sole trader would be £12,500.

Tax Implications for Setting up an Incorporated Company

An incorporated company is less risky than a sole trading business because here X and the business will be treated as a separate entity. In this case, the business will be responsible for its finance and not X’s finances. But, one of the disadvantages of an incorporated company is that any profit that it makes is retained by the company and X’s share would be limited to the extent of paid-up equity capital of X. In this case, it is £125,000. Additionally, X will have to put in statutory accounts and send an annual tax return to the Companies House and HMRC. Again if X expects earnings of more than £77,000, X will have to register for VAT. Thus, in this case, X will have to pay tax @ 20% on £125,000, i.e. £25,000, and will still have £100,000.

Tax Implications for Investment in Government Bonds

Generally, investment in government securities is less risky compared to corporate bonds because there is less chance of default. Consequently, the reward for such investment is also low compared to investment shares or other classes of assets. Banks are always under the supervision of Government agencies like the World Bank and IMF which reduces the chance of default in case the banks file bankruptcy. But to a limited extent, the risk of default, market risk, and daily fluctuations remains (Wahab & Holland, 2011, pp.3-10). For instance, X can invest in German Bund yielding 0.22%, 0.69%, 1.67%, and 2.44% for 2 Yr, 5 Yr, 10 Yr, and 30 Yr periods. If the bond is cashed in before maturity to the extent of more than 5% of capital, there is no extra tax for low-bracket individuals. But, X falls under a higher tax bracket (annual income over £150,000), so he’ll have to pay 20% extra in addition to the difference between the 20% already paid by the fund. Investment in bonds is only attractive to senior citizens and pensioners. So, in this case, X will have to pay a minimum tax of £25,000.

Tax Implications for Gifting to Children

Inheritance tax is paid on the estate inherited by the beneficiary when someone dies leaving a house, gifts, or cash for the beneficiary. It is payable at the rate of 40% over £325,000 for the tax year 2012-13. In X’s case, it is exempted because £125,000 is below the threshold of £325,000. However, if X believes the threshold might exceed in the future, inheritance tax can be avoided by passing the money or property to four children or by gifting it to X’s partner or any qualifying charity established in the EU. Such gifts are exempted from inheritance tax and hence it will allow X to avoid inheritance tax.

Conclusion & Recommendation

After considering all the options available to X and also evaluating the advantages and disadvantages of each of them, it can be said that if X wants to minimize the tax implication of £125,000, the amount should be gifted to X’s children for which X will not have to pay any tax.