The move to Partner is not just a promotion. In a professional partnership, it is a transformation of the individual’s employment status. The move from being an employee to an ‘equity partner’ changes the way a person is taxed and how they pay tax. New partners need to make sure that they understand this transition.
In most cases, when an individual becomes a partner, they will be treated as self-employed for tax purposes — which has significant consequences.
Moving to self-assessment
As an employee, individuals pay income tax and National Insurance on earnings received from their employer. However, partners pay income tax and National Insurance on the taxable profits allocated from the partnership. It is important to note that the amount of profit allocated to a partner — and therefore subject to tax — can be different to the amount paid to them as a drawing from the partnership.
The income tax rates applied to partnership income are the same as those for employment income: progressive rates of 20%, 40% and 45%. However, partners who are treated as self-employed are required to file a UK tax return — unlike most employed individuals who, with certain exceptions, are not. Self-employed partners must register for self-assessment by completing a Form SA401, notifying Her Majesty’s Revenue and Customs (HMRC) that they are a partner.
Crucially, while employees have taxes deducted at source from their monthly pay through the Pay-As-You-Earn (PAYE) system, partners do not. Their allocation of partnership profit is typically paid out gross in the form of drawings and bonuses, with no taxes withheld. Instead, a partner is likely to fall within the system of payments on account, requiring them to pay tax twice a year:
- 31 January (within the tax year)
- 31 July (after the tax year ends)
Each payment on account is usually 50% of the previous tax-year’s tax bill.
Some partnerships operate a form of internal withholding from the partners, drawing to help partners with cash flow planning. The money is held in a tax account for the partners from which they can make the tax payments when they are due.
Content source: https://www.ey.com/en_uk/ey-frank-hirth/tax-implications-employee-to-partner
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