Guide #16: How to Boost Earnings by Reducing Revenue

The tax advantage of small businesses

When I was trying to get my first businesses off the ground, I didn't spend any time thinking about tax, or learning about the tax system. I was putting all my efforts into learning how to build a business.

I figured that tax is a problem I would look at when I was actually making money.

And although that was not a terrible idea, when I eventually did start making money, I soon found myself landed with a huge tax bill that I hadn't prepared for.

I had hit multiple tax thresholds, racked up enormous tax bills and given myself only a few months to make the money.

I felt very naive.

I had put so much effort into making money, that I had completely neglected the fundamentals. I knew nothing.

I swore to myself that it wouldn't happen again so I started learning about business taxes and how to extract money in tax efficient ways.

I studied every possible route of extracting money with minimal tax (in legal ways) until something hit me.

I could make more money by making less money

This sounds counterintuitive but because of tax thresholds, it meant that once I reached certain revenue, I was actually keeping less of every $1 made, which meant that my equivalent hourly rate dropped for every extra $1 made.

Until this point, I had followed all the growth gurus on Twitter who all pointed me towards revenue growth and methods on scaling your business. But my focus was to build a lifestyle business. Not to build the next Apple or Amazon.

I realized as a solo-founder, it made more sense to intentionally limit my revenue below certain tax thresholds, simplify the business operations without the need to scale a team or systems and take the optimal amount of take-home revenue whilst avoiding massive tax bills.

Let's take a look at how this looks in practice. Since every country has their own tax system which differ greatly, I would strongly recommend looking into the most tax-efficient ways to extract money from your business wherever you are. For example, in the UK where I'm based, the most efficient way to extract income as a company director is through a combination of a small salary coupled with company dividends (shares of profits). Sometimes the setup can be a little complicated, so let's invent a very generic fictional tax system to illustrate how this works.

The fictional tax system

Let's say your country/region has a standard corporate tax rate where they charge your company a fixed 20% on all profits (this is paid by the company).

Now let's say that the most efficient way to extract money is to take dividends from these profits. Then the personal dividend tax rates look something like this:

• $0-50k = 10%

• $50-100k = 25%

• $100k+ = 45%

Example 1

Now let's say you make $125k profit for the year and decide to extract that as dividends. Firstly, you pay the flat 20% corporate tax rate which is $25k. Then let's apply the dividend taxes and see how that comes out:

• $50k at 10% = $5k tax

• $50k at 25% = $12.5k tax

• $25k at 45% = $11.5k tax

The result is $29k in personal taxes on top of the $25k company taxes. In other words, to extract the $125k, you've paid a combined $54k through company and personal taxes and only kept $71k of the original $125k.

You will notice for the top tax bracket, you paid almost as much tax ($11.5k) as the bracket below it($12.5k), despite taking only half the amount of money.

The big jump here is the 45% tax on all income over $100k. Combined with the corporate tax rate, you’re losing 65% of your income here, so what would the effect be if we intentionally keep our profit below this threshold?

So let’s look at another example.

Example 2

Instead of making $125k profit, we aim for $100k.

Again we have the corporate tax rate of 20% but now we only pay $20k, not $25k.

Now let's do the dividends.

• $50k at 10% = $5k tax

• $50k at 25% = $12.5k tax

This time we're only hitting the first 2 tax brackets, so the total personal tax is $17.5k instead of $29k, resulting in a combined corporate and personal tax of $37k, meaning from the original $100k, you're left with $63k which is only $8k less than our first example where we made an extra $25k.

Comparing both examples

Side by side they look like this:

• $125k - $54k tax = $71k take home

• $120k - $37k tax = $63k take home

This is only half the picture though because scaling your revenue often includes other important changes to your business, namely;

• more complex systems

• more staff

• more time investment from you

Systems and staff both add cost to your business which will also reduce your profits and affect how much you can take home personally. Again, if you're trying to build a big company then that's all fine, but it doesn't make any sense for a lifestyle business.

Perhaps the most important point there though is the fact that the business requires more time investment from you. As I've said in many of my other guides, the whole point of a Tiny Empire is to untie your time from your revenue stream as much as possible so that you're not only getting paid when you're online. But even when you've completely removed your time from the revenue stream, it's usually true that dedicating more time will still grow your business, because you can dedicate your time to other areas of growth. But as this example shows, if you are dedicating your time to grow revenue, you may be counterintuitively making your time less profitable. Let's take one more look at the previous examples but this time apply some fictional work hours to them.

So in the $100k example, let's imagine it took 20 hours of work per week to achieve this revenue and let's say you only worked 48 weeks in the year. That gives us 960 total hours spent annually . That comes out at $65/hour after tax.

For the $125k example, let's imagine it took 25 hours of work per week to achieve this revenue and again you only worked 48 weeks in the year. That means 1200 total hours spent and comes out as $59/hour after tax. So you made $6 less for each hour worked.

In conclusion

Of course these are all fictional numbers, but the point is that you can often think that working more can result in a better business, whereas the actuality is that you could have a far simpler, more efficient and profitable business by scaling back, setting specific revenue goals and then using your time efficiently to reach those goals.

For me, this realization changed the way I thought about business and is the catalyst that sparked the Tiny Empire idea in my head. If you are interested in applying a similar strategy, I would recommend talking to an accountant in your area and make sure they have a good understanding of how to make your business tax efficient. I would also advise reading online government tax information so you have a good understanding of it yourself. The optimal size of business differs from country to country based on these tax laws and thresholds so understanding it is one of the biggest money savers you can get for your business.

Good luck

---

If you found this useful, I share 15 years of startup learnings in 3-min guides every week. Subscribe here to get every guide for free.