Sole trader or limited company and Choosing your business structure to save tax ?  Previously I talked about the differences between a sole trader and limited company.  What you need to consider when deciding what business structure, you should adopt.

You cannot make that decision without looking at tax. Moreover, how it works and how much you pay, and which is better.  When it comes to crunching the numbers, I have just the thing for you!  FREE online business and tax calculators. More of that later.

Sole traders and taxation

HMRC refers to sole traders as self-employed so that’s the term I will use.  In normal speak self-employed refers to working for yourself.  As a sole trader, or you pay pay Income Tax and National Insurance on your tax profits. Furthermore, the tax people (HMRC) see your profits as your income, just as they would see wages and salaries as income.

The good news is that some of your tax profits are free from income tax and National insurance.  Most people in the UK get a Personal Allowance of tax-free income. That tax free pot applies to income from all sources, for example self-employment, rental profits, wages and salaries.

What is National Insurance

You pay National Insurance contributions to qualify for certain benefits and the State Pension.  Moreover, National Insurance is a tax.  This is often overlooked by many self-employed businesses.  It is not highlighted as tax, but it most certainly is.    If it looks like a tax, walks like a tax, quacks like a tax then it is a tax.

Firstly, the amount of tax profits that escape National insurance is less than it is for Income tax.

Two types of National Insurance are paid if you’re self-employed, for 2021-22 it is

  • Class 2 if your profits are £6,515 or more a year
  • Class 4 if your profits are £9,568 or more a year

Check out our FREE online tax calculator to crunch those numbers.

Limited Companies and Taxation

What happens when your business is a limited company?  As mentioned in last week's blog, when you have a limited company, the law, regulators, and tax authorities recognises sees two people.  Your company and then you, the owner and director. A limited company is a popular choice when Choosing your business structure to save tax.  Personal service companies are now very restrictive for tax planning.

What tax does your company pay?

Your UK company will pay corporation tax on all the profits that it makes.  Profits has a broader meaning than for sole traders and is not just the profits you make from your products and services.  Profits include other profit sources, for example interest income, rental income and any capital gains.

Your company will pay corporation tax on the profits it makes,

It is important to understand the general rules of Corporation tax as it differs from Income tax and Capital Gains tax, from the percentage of tax chargeable, the date the tax is due, all the way to the way it is filled out on the Tax return form.

Corporation tax rules apply to all companies, private, not for profit, limited by guarantee, social enterprise Charities and Sports clubs.

What tax do you pay as the director and owner of your company?

 You will pay income tax on the money you pay yourself.  You need to pay yourself so you can live, pay your bills, relax, and reward yourself.  The two most common routes are salary plus dividends.  There is third way, and that's bey using a benefits strategy.

Paying yourself a salary

Your company is your employer, and for practical purposes you are its employee.  Put yourself on the payroll and operate PAYE.

Introduction to PAYE

PAYE was introduced into the UK in 1944, following trials in 1940–1941.  The financial strain that the Second World War placed upon the country meant that the Treasury needed to collect more tax from many more people. This posed significant challenges to the government and to the many workers and employers who had previously never meet the tax system.

As an employer, your company will have to operate PAYE as part of your payroll.  PAYE is HM Revenue and Customs’ (HMRC) system to collect Income Tax and National Insurance from employment.

How dividends are taxed

Paying yourself a salary is one to pay yourself.  Dividends are another option, but not the only one.

Dividends are your company profits that you are paying yourself.  The equivalent term for the self-employed are drawings, cash or goods taken for own use.

Tax, or reducing tax plays a big part behind why owners pay themselves dividends.  Company tax, personal tax and national insurance are all part of that balancing act in deciding how much you should take.

Add to this your personal tax situation, from basic rate taxpayer and beyond.  You’ve a heady cocktail of thought processes going around.  Your dividend will be part of your personal income, with tax rates being as low as 7.5% if you are a basic rate taxpayer, rising to 32.5% for higher rate taxpayers to a 38.1% if your income is over £150,0000.

Tax is not the only thing to consider.  Control plays a part in how much dividend you pay.  If you’re the director, you decide when you pay your dividend.  For example, child benefit is not available where you or your partner have income over £50,000.

You also get a dividend allowance each year. You only pay tax on any dividend income above the dividend allowance.

Conclusion

This vlog and blog will help deal with Choosing your business structure to save tax . What is the best business structure for saving tax depends on many variables, companies normally present the better opportunities once you make healthy profits.

Our FREE online business calculators are here to help you get a better understanding about your numbers, making profit, giving you options, saving you time, improving your money mindset. and setting your goals. Get a better understanding of your numbers. Type in your numbers and see what they say!

Get in touch with us to see how we can help you with your sole trader and company accounting and tax needs. For more business and finance , news, advice and tips, don’t forget to watch our weekly broadcasts, listen to our weekly podcast I Hate Numbers.

 

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