In some cases, you could pay less tax overall on the same amount of money earned if you trade through a limited company rather than as a sole trader. This will depend on the level of your income and how you take it from your company.
When you’re a sole trader, you payincome tax on your business’s profits above the personal allowance, as well as national insurance above certain thresholds.
When your business is a limited company, different taxes and national insurance can apply to your company and to you personally, depending on how much money you take out of the business. A notable difference is that a company pays corporation tax on its profits.
Depending on how much profit the company makes and how much money you want to take out of it, you may be able to use a combination of salary (which you pay to yourself as anemployeeof the company), dividends(which you pay to yourself as ashareholder) and loans from your company to maximise the money you receive.
There are lots of trade-offs, and the best outcome is very much dependent on your circ*mstances. For instance, a salary reduces your company’s profits subject to corporation tax but is generally subject to higher income tax through PAYE compared to dividends and loans. There’s no national insurance payable on the income you receive in the form of dividends, so small businesses tend to take a salary below the national insurance thresholds and the rest as dividends.
Overall, the tax advantages of using a limited company have been eroded over the years, and from 1 April 2023, the corporation tax main rate for profits over £250,000 increased from 19% to 25%. Companies with profits of £50,000 or less continue to pay corporation tax at 19%, but between £50,000 and £250,000 a tapered rate applies, going up gradually to 25%.
You also need to bear in mind that before you pay a dividend, you need to make sure the company has enough retained profit to cover it – and corporation tax must come off the company’s profits before you pay out any dividends.
You have to prepare dividend vouchers every time the company pays out. Accounting software likeFreeAgentcan help you check that the company has enough profit to pay a dividend. FreeAgent can also prepare dividend vouchers for you.
