Taxation is a topic that often leaves business owners scratching their heads, especially when it comes to choosing the right business structure. For many businesses and freelancers, the decision often boils down to being a Sole Trader or a Limited Company.

Self Employment vs. Limited Company

Before we delve into the tax intricacies, it is important to briefly cover the fundamental differences between the two business structures:

Self Employment: Sole Trader/Partnerships:

  • As a Sole Trader or a Partnership, you and your business are one legal entity.
  • You’re personally responsible for all aspects of the business, including debts and liabilities.
  • You report your business income on your personal tax return.
  • Income tax is calculated on your total income, including business earnings.

Limited Company:

  • A Limited Company is a separate legal entity from its owner(s).
  • Owners typically have limited liability, protecting their personal assets from business debts.
  • The company files its own tax return, and profits are subject to Corporation Tax.
  • Owners can pay themselves a salary as employees, which is tax-deductible for the company.

The crux of the Sole Trader vs. Limited Company debate often hinges on income tax and corporation tax rates:

Income Tax:

  • For Sole Traders, income tax rates are applied to your entire income, including business earnings.
  • The tax charges are dependent on income and the rates can change each tax year but the current income tax rates are typically ranging from 20% to 45%.
  • You may also be eligible for a Personal Allowance, which is the amount you can earn tax-free.

Corporation Tax:

  • Limited Companies pay Corporation Tax on their profits.
  • The current Corporation Tax rate is 19% for profits up to £50,000.
  • Corporation tax rates since April 2023 have been raised to 25% on profits over £250,000.

Is there a Double Taxation with taking an income from a Limited Company?

One concern often raised about Limited Companies is the fear of double taxation. Corporation Tax is due on company profits and then the shareholders may be taxed on their personal income such as salary and dividends.

However, this double taxation scenario can be effectively mitigated by paying yourself a salary as an employee of your Limited Company. Your salary is considered a deductible business expense, reducing the company’s taxable profits. The remaining profits can then be distributed as dividends, which are taxed at a lower rate than regular income tax.

This is why careful tax planning is important to ensure that you are maximising your ‘take home income’ by having the correct amount salary vs dividends.

Benefits of Paying Yourself through a Limited Company

Here are some benefits of paying yourself as an employee through your Limited Company:

  • Tax Efficiency: By taking a combination of salary and dividends, you can optimise your tax liability, potentially paying less tax compared to being a Sole Trader.
  • Limited Liability: Limited Companies offer personal asset protection, reducing your exposure to business debts and liabilities.
  • Professionalism: Operating as a Limited Company often conveys a more professional image to clients and partners, enhancing your business’s credibility.
  • Opportunities for Growth: Limited Companies may find it easier to secure financing and investors, facilitating business expansion.

In the Sole Trader vs. Limited Company tax efficiency debate, the answer largely depends on your specific circumstances and financial goals. While Limited Companies may initially seem more complex, they can offer substantial tax benefits, especially when you pay yourself a salary that’s tax-deductible for the company.

Consulting with a qualified accountant or tax advisor, like the team here at Cooper Accounting is crucial to helping you make an informed decision tailored to your situation.

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