When starting a new job, the focus is usually on the opportunity. However, partnership moves need to be planned carefully, as they almost always result in a complex tax year for the partner, as well as the two firms, involved.
Overlap profit – impact on tax returns and pension planning
Partners moving firms are subject to special opening and closing year tax rules. Careful tax planning and consideration of the optimal leaving date is advisable to maximise tax relief on overlap profit, depending on how the old firm’s year-end relates to the tax year. Generally, a partner’s taxable income is the profit arising in the 12-month period ending in each tax year.
Overlap profit is profit that has been taxed twice in the opening years of commencing in a partnership, with credit usually only given in the tax year a partner leaves. The amount initially taxed twice can be considerable if a signing-on bonus is offered.
Many firms account for the future deduction of overlap profit in their tax reserving policy for partners and it’s important partners understand this as it will impact on their distribution of profit.
It’s not unusual for partners to file a provisional tax return in the tax year they move firms to include an estimated profit share from one, or both, firms for the current year. This can have implications for pension planning, given the restrictions on contributions, which should be revisited within 12 months of filing the provisional return.
Strain on partners’ capital accounts
Firms that are well prepared for the impact of the various Brexit scenarios may also be in a better position to advise their clients with EU exposure and could gain a significant competitive advantage.
The requirement to buy in to a new firm can cause financial complexity if the partner has not yet been repaid capital by the old firm. For LLPs subject to salaried
member legislation, new members are only granted a two- month grace period to introduce capital to the business.
A new personal loan may be required to bridge the gap between the repayment of capital from the old firm and introduction of capital in the new firm, which may have implications for other personal loans such as mortgages. Tax relief on interest paid on a partnership capital loan is only available for the period as a partner of the firm in which the capital is invested.
Many firms can also hold on to partners’ tax reserves for lengthy periods. If there are any open enquiries into partnership tax returns, it could be a number of years before the tax position is completely tidied up.
Clearly, this will also have implications for the partner’s funds available for other expenditure such as mortgage repayments, school fees or the ability to make regular pension contributions.
All of this underlines the importance of careful tax and financial planning. Many firms now provide financial education and ‘tax surgeries’ for partners to help them understand the various complexities.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.