For family business owners, keeping a large cash reserve in the business bank account might seem like a safe strategy. After all, it provides a cushion in case of emergencies and might even feel like a way to avoid taking unnecessary risks. However, while this may seem like a conservative approach, it can have some long-term implications, particularly regarding taxes and the business’s future.
At The Wealth Coach, we often advise clients on how to manage their business profits in a way that reduces tax liability and increases financial security. Here’s a look at why leaving cash sitting in the bank could lead to unwanted tax consequences and what options you have to extract profits from your business more efficiently.
When business owners hold onto large sums of cash, it can lead to tax issues down the line. Specifically, it could affect the business’s eligibility for two vital tax reliefs: Business Relief and Business Asset Disposal Relief
Business Relief is a tax relief designed to reduce the value of a business for inheritance tax purposes. However, businesses with large cash balances may no longer qualify for this relief. If your business loses eligibility for Business Relief, its value could be included in your estate when you pass away, meaning it would be subject to inheritance tax.
This can lead to a hefty IHT bill, which may reduce the amount you’re able to pass on to your loved ones. It’s crucial for family business owners to be aware of this risk and take steps to avoid it.
Business Asset Disposal Relief (formerly known as Entrepreneur’s Relief) allows business owners to reduce the rate of capital gains tax when selling the business. Instead of paying the higher rates of CGT (18% or 28%), business owners can reduce this to just 10%.
However, as with Business Relief, holding a large amount of cash in the business could disqualify you from Business Asset Disposal Relief. This would mean that if you sell the business, you may end up paying a higher rate of CGT, reducing the overall value you get from the sale.
Rather than keeping large amounts of cash in your business account, it’s wise to consider more tax-efficient ways to extract profits. At The Wealth Coach, we work with business owners to explore a few strategies that could help you make better use of your business profits.
One of the most tax-efficient ways to extract profits from your business is by contributing to a pension. Pensions offer a range of tax benefits that can help you maximise your savings while reducing your overall tax bill.
For business owners, the government’s pension tax relief acts as a “top-up” on the contributions you make. The more you contribute to your pension, the greater the tax relief you receive. Converting excess profits into pension contributions allows you to avoid the income tax implications of taking money out as a salary or dividend.
Another advantage of pension contributions is that any unused pension contribution allowances can be carried forward for up to three years. This is particularly useful for those who want to invest a large sum but have already used their annual allowance.
In some cases, business owners may still have surplus profits that need to be invested. One option to consider is government-approved tax-efficient investment schemes, such as Venture Capital Trusts (VCTs).
VCTs allow you to invest in early-stage businesses and, in return, you can receive generous tax breaks, including 30% income tax relief on the amount you invest. This can offset some of the tax implications of withdrawing large sums from the business.
However, VCTs do come with higher risk and are best suited for business owners who are comfortable with adventurous investments.
Another option for family business owners is to withdraw excess cash and invest it in other Business Relief-qualifying assets. These could include investments in other companies or portfolios that are outside of your estate for inheritance tax purposes. By doing so, the assets can be passed down to your beneficiaries without incurring an inheritance tax liability.
Estate planning is a crucial part of protecting your family’s wealth, and this strategy allows you to safeguard your business and investments from future tax liabilities while keeping the value of your estate intact.
While holding onto large amounts of cash in your business account might seem like a secure strategy, it can lead to potential tax consequences that could affect your long-term financial security. Business Relief and Business Asset Disposal Relief are both valuable tax incentives for family business owners, but they come with conditions—especially when it comes to cash reserves.
At The Wealth Coach, we help business owners make the most of their profits by offering tax-efficient strategies like pension contributions, VCTs, and estate planning. By taking proactive steps to manage your business’s cash flow, you can reduce your tax liabilities, protect your legacy, and ensure the financial future of your business and your family.
If you’re a family business owner looking for advice on how to extract profits tax-efficiently, feel free to get in touch with us at The Wealth Coach. We’re here to help you navigate the complexities of tax planning and ensure your financial well-being.