Should Your Business Become a Limited Company?
The question of when, or if, to become a limited company crops up frequently and the decision, as always, depends on the individual business circumstances. Of course the possibility of a financial saving is a major factor for many businesses if they incorporate or, indeed, set up from the start as a limited company.
And it is not just high earners who can save money by incorporating. Even low earners can save on NI contributions.
Take a sole trader with a profit below both the personal allowance and the Class 4 NI lower limit. That worker will have no tax to pay but if he/she earns above the small earnings exception (currently £5,885 for the 2014/2015 tax year) then Class 2 NI contributions will be due.
If that same person had operated through a limited company and withdrawn the same profit solely through a salary (and not via a dividend) there would be no tax to pay but also no NI contributions to make. At a salary level above the lower earnings limit he/she would also retain any contribution record for state pension and benefit purposes.
Consider a sole trader who makes a profit of £50,000, part of that profit, under the personal allowance, will not be taxable, part of it will be taxable at the basic rate of income tax and part at the higher rate of income tax. Class 2 and Class 4 National Insurance Contributions (NICs) will also be due.
For the 2014/2015 tax year income tax and NICs will amount to £12,985 on profits of £50,000.
Consider instead an incorporated business that makes the same profit of £50,000. The owner will receive a small salary of less than the current personal allowance and will receive the remainder of the profit as dividends.
For the 2014/2015 tax year the corporation tax, income tax and employees NICs will amount to £9,076 on profits of £50,000 leaving the owner of the limited company £3,909 better off than a sole trader with the same level of profits.
If the same owner had taken a lower dividend, below the basic rate limit, and left some profit in the company then he/she could have saved more than a further £800 of tax.
Other Factors to Consider When Considering Setting Up a Limited Company
Start Up Losses
If significant losses are expected in the initial years of the business then consider that as a sole trader you could offset those losses against other income from the preceding 3 years.
When You Pay Tax
As a limited company you only pay tax after the end of a tax year so you know exactly how much profit the company has made. This can make a difference for those businesses with seasonal or irregular income.
There are many reasons why someone might prefer to be a sole trader, for instance retaining privacy over the business accounts and other business details. But, equally, there are many businesses that want to take advantage of limited liability status so personal preferences will always be a factor in the decision of whether to incorporate or not.
Depending on the type(s) of vehicle that a business owner uses it is possible to save more tax if you undertake business as a sole trader.
Additional State Pension
The Class 4 NICs that you might make as a self-employed sole trader do not contribute towards your state pension and other benefits. However, if your business is set up as a limited company and the company pays you a minimum salary you will not have to pay NI on that salary (provided it is below the current threshold) but you will still be entitled to the additional state pension and other benefits.