Limited company/corporation tax question

[lordharvey]

Hi, I have a quick question about contracting through my own limited company.

I am currently a sole trader with an income in the high £20,000s range. Based on the growth trajectory of my business in the past year (new client wins) it is likely that my earnings will push me into the additional income tax rate, i.e. over £~42k or whatever it is exactly, in the 2018/19 tax year.

I have multiple clients and am not a disguised worker so IR35 won’t matter.

I have been reading up on the tax advantages of becoming a limited company and employing myself as the only worker.

I understand the small salary/high dividend split - i.e. that rather than pay myself everything as sole trader profits, I pay myself minimum wage then take the rest as dividends, which I understand at this bracket would be taxed at 7ish %.

What I don’t understand is how, given that these dividends are considered profits, the tax savings of this model won’t be wiped out by 19% corporation tax on all profits.

Wouldn’t I have to pay 19% corp tax, + 7% dividend tax = 26% tax on most of the dividends? Even with the personal allowances etc built in, this just seems like a similar tax sum to what I’d pay if I stayed as a sole trader.

If accountants are recommending this model left right and centre as a tax efficient alternative, then surely this can’t be right. But I can’t see where I’m going wrong, and I can’t find advice online about it. I do have an accountant appointment but not until Easter for various reasons.

Any advice greatly appreciated.

You're forgetting about the NI which you won't pay on the dividend. You do need to make sure that you pay yourself enough salary to gain NI credits though.

Main downside is the admin costs e.g. tax returns, setting yourself up as an employee. Main upsides are tax in many ways and the limited liability.

There is little difference on profits around £30k either way. There used to be a couple of thousand of savings at this sort of profit level, but the new dividend tax (2016/7) killed it off. The savings at relatively low profit levels of £25-£35 was always NIC which the new dividend tax has made up.

It's now on higher profits where savings can be made, i.e. around the higher rate threshold and beyond. One main reason is that you have the ability to plan dividends, so if you don't need to withdraw all profits, you can keep them in the company, thus avoiding the 7.5% dividend tax and also potentially avoiding higher rate tax.

I.e. if you made £60k as a sole trader, you're stuck with higher rate tax and losing child benefit (if being claimed). That's whether you draw the full £60k or not. Whereas with a ltd, you make £60k, but can choose to draw wages and dividends up to the higher rate threshold, so you don't suffer h/r tax and don't lose child benefits, with the surplus being left in the company. Can make quite a difference if your reinvesting profits in stock or if you want to build up funds for a sabbatical or other time off as you can then draw down the dividends in a later tax year, maybe when you aren't working or income is a lot lower.

If accountants are recommending this model left right and centre as a tax efficient alternative

Not so much these days for relatively low/average incomes. Go back 10-15 years and even the smallest of businesses, i.e. window cleaners, dog walkers, etc were converting to limited companies, but the tax breaks have been eroded in more recent years. Last year, there was the £5k tax free dividend rate band, but even that is being eroded by being reduced to just £2k from April 18.

These days, incorporation is more about long term tax planning, personal asset protection, etc rather than income tax savings.

what about setting up as a LLP - Limited Liability Partnership - which (I believe) you can do as a single person ?

Being a ltd company it will incur costs circa 1k a year for your accountant. I think LLP costs would be a lot less.

Also - you can , if I remember correctly, put any profit you have directly into a Pension - I have a SIPP - self invested pension with hargreeves landsown. This means you dont pay tax on what you invest in - but you will pay tax on it when you pull money out. Maybe an option for you.

42k profit would save around £1250 ish in overall tax after accounting for Corp tax etc (off the top of my head, v. rough calculations).

Could be much of this would be subsumed in accountancy fees.

If 42k is going to be your max level of profit for you it probably wouldn't be worth it unless you want the protection trading through a limited Co offers.

If however the business is growing it may be that this is a sensible option if not now than in the future.

It would be worth seeing an accountant and taking advice.

42k profit would save around £1250 ish in overall tax after accounting for Corp tax etc (off the top of my head, v. rough calculations).

That assumes the £5k zero rate dividend allowance. It's being reduced to just £2k in April, so you can knock £225 of the savings.

There are also other factors to consider, such as the number of business mileage you do and the costs of your car. How you claim for your car travel costs can have a massive impact on the "sole trader versus company" comparison. I.e. if you have an expensive car but do low mileage, it could save you thousands in tax as a sole trader compared with being a ltd company.