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Do You Have To Pay Tax On Cash Out Refinance – Using the cash basis for tax filing is a popular choice for self-employed businesses because it allows for bookkeeping and
Read on to learn everything you need to know about the cash basis of filing your tax return, who can use it, and the pros and cons of doing so.
Do You Have To Pay Tax On Cash Out Refinance
Friendly disclaimer: While I am an accountant, I am not your accountant. The information in this article is legally correct but is provided for guidance and information purposes only. Everyone’s situation is different and unique, so you will need to use your own best judgment when applying the advice I provide to your situation. If you are unsure or have questions, always contact a qualified professional as mistakes may result in penalties.
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Using cash basis means you report the income and expenses you actually paid on your tax return. Therefore, you only pay tax and National Insurance on the money you receive from clients and consumers.
An alternative to cash basis is traditional accounting, which includes revenue and expenses that have been invoiced or billed. This can make the preparation of your income and expense statements more complex and time-consuming, especially if your tax affairs are fairly simple.
Cash basis can only be used by sole traders who have a turnover of £150, 000 or less during the accounting period. (£300, 000 if claiming Universal Credit). Once you choose to use cash basis, you can continue to use it until your turnover reaches £300, 000.
Cash basis is a very popular option for self-employed people. Those who handle their own taxes often choose it because:
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+ You only pay tax on the income you have paid. So if your client is slow to pay, you won’t pay HMRC until you receive payment.
+ You avoid dealing with capital allowances (except for cars), meaning you get full tax relief on any major expenses in the tax year you pay them.
+ It makes preparing your income and expense statements easier because you can use your business bank statements to find your income and expenses without looking at invoices.
Despite some clear advantages, cash basis is not always suitable for everyone. Some people choose to use traditional accounting instead of cash basis accounting when:
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The accounting method that’s right for you really depends on your personal circumstances. Let’s say that in tax year 2022-2023 you invoice a customer for £2, 000 and they send you a partial payment of the invoice for £1, 000.
When using cash basis, you only need to include £1, 000 of income in your tax return. However, with traditional accounting you would need to show the full £2, 000 and pay tax on it.
However, let’s say you are building your business and have been invoiced for £5, 000 for your new website. You pay just £2, 500 to your web developer during the 2022-2023 tax year and agree to pay the balance sometime in 2023-24.
Using the cash basis, you can claim £2, 500 as fees in 2022-23 and the rest the following year. However, using traditional accounting you can claim an invoice value of £5, 000 in a tax year. This means you get tax benefits early on.
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You can change from cash basis to traditional accounting between tax years, but you must use the same accounting method for each complete accounting period. You must also have a reason for making the change, such as taking advantage of tax losses. If you want to switch between the two, you’ll need to make sure you adjust the numbers on your tax return. This is to ensure you don’t double count or omit income and expenses.
HM Revenue and Customs (HMRC) has a worksheet you can use to help you calculate the adjustments you need to make to your tax return.
Any losses arising from the conversion of the business from a traditional model to a cash basis can only be carried forward. They cannot be used as a horizontal relief against other income or deducted from the previous year’s profits.
For some people, the cash basis not only reduces their tax bill but even creates a loss in tax revenue. However, to keep things fair between every self-employed person, HMRC sets rules on how these losses can be used: The market has not continued the momentum of the last two weeks of 2023. At the end of the first week, ES3 was down 1.7% and SPY was down 0.8%. Since I don’t like to go short and don’t use options, my portfolio generally tracks the market and is down 1.7% in the first week.
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While it may not feel pleasant, especially after enjoying the excitement of the past two months, this kind of volatility is common in the stock market. I think our brains are tricking us because it’s marking 2023 for gains and 2024 for losses.
Imagine if there were 53 weeks in 2023 and yesterday was the last trading day of 2023, we might be celebrating good performance this weekend. It’s still early, so don’t let a mere 4-session drop affect your mood and/or plans.
The reporting period is coming soon, and some companies will announce their results as early as the end of January. That’s the real thing, and that’s what we should be focusing on.
At this time of year, you will see a lot of people, especially those in the financial sector, sharing their provident fund top-ups. It has real benefits, like earning 4% interest on your SA account and saving you $8,000 in tax for yourself, or $16,000 if you top it up for a loved one too.
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Of course, if you plan to top up, it’s best to do it as soon as possible, because provident fund interest is calculated on a monthly basis (based on the lowest amount in the month). You can refer to the Provident Fund website for more information on top-up.
Now the most obvious reason is that I have reached full retirement pension (FRS) so I can no longer top up CPF-SA. But why didn’t I top up my provident fund in the past?
The main reason for me is that I don’t like having my money locked up! Top up to CPF-SA and I can use it as early as age 55. So by the time I’m in my 30s, we’re talking about 20 years of me not being able to use it!
Don’t get me wrong, overall I do like our CPF system. However, locking in 37% of my total salary for the future is enough. I’d like to have more control over how the remaining amount is used.
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The second reason is that over such a long runway, I have a good chance of earning returns above 4%, which makes the income tax deduction savings much less attractive. This may be because my income is not very high. Combined with other deductions, I didn’t pay high income taxes most of the time.
To be honest, I didn’t do the math at the time. Given that I value liquidity, I don’t need numbers to convince me otherwise. However, I am now curious and have calculated how long it will take to recoup the tax deduction at different rates of return.
As shown in the calculation above, with a top-up of $8,000 and a tax rate of 7%, you’d save approximately $560. If the average rate of return can reach 6%, it will take 4 years to earn back this benefit. The return is as high as 8%, and you can earn back the tax deduction in just 2 years!
What’s more, people will definitely benefit more from higher returns in the long run. The problem is that unlike the 4% interest on a CPF-SA account, higher returns are not guaranteed. Having said that, with a long runway, a 6% return is perfectly doable.
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Of course, if one’s income is higher, tax breaks become more attractive. Although it is no longer relevant to me, I now think it might be a good thing to top up the CPF only when one is hit by higher tax rates.
As mentioned earlier, tax breaks at lower rates are not that attractive. Additionally, top-up in earlier years means a higher likelihood of reaching FRS earlier. This means that the higher your income, the higher your tax deductions will not be!
Looking back now, I don’t regret not topping up my provident fund. I thank my younger self for taking calculated risks in pursuit of higher non-guaranteed returns.
These are referral links to services and platforms I use. If you would like to use any of these, please sign up for my referral link. Top up your own or your family member’s CPF special/retirement account and claim tax relief to meet basic retirement needs.
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CPF cash top-up relief aims to encourage Singaporeans and permanent residents