How to become a limited company
Whether your business should become a limited company depends primarily on the individual circumstances of the business. One of the key factors determining a move to limited company status – or indeed setting up a business as a limited company from the outset- is the possibility of making a financial saving.
How can a limited company make a financial saving?
Businesses with both small and substantial revenue can potentially save on National Insurance contributions if they operate as a limited company.
Low income businesses:
A sole trader with a profit below the personal allowance and the Class 4 National Insurance lower limit will not be liable to pay any tax, but if they earn above the small earnings exception (£6,025 for 2017/18 and £5,065 for 2016-17), then they will be liable to pay Class 2 NI contributions.
If that same person had operated through a limited company and withdrawn the same profit solely through a salary – and not via a dividend – they would not have to pay tax or NI contributions. At a salary level above the lower earnings limit, they would also retain any contribution record for state pension and benefit purposes.
High income businesses:
A sole trader who makes a profit of £50,000 would benefit from part of the profit being non-taxable, due to the specifications of their personal allowance. The remainder of the profit would 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 would also apply.
If an incorporated business made the same profit of £50,000, the business owner would receive a small salary of less than the current personal allowance and would still receive the remainder of the profit as dividends.
For the 2017/2018 tax year, corporation tax, income tax and employee NICs would amount to £10,076 on profits of £50,000, leaving the owner of the limited company £2,187 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 they could have saved further tax.
Pension contributions in a limited company
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 operates as a limited company and the company pays you a minimum salary, you would not have to pay NI on that salary, provided it is below the current threshold. You would still be entitled to the additional state pension and other benefits.
Alongside financial savings, there are several benefits to operating as a limited company, including:
-Offsetting start up losses – as a sole trader you could offset any start up losses incurred in the first years of trading against income from the preceding three years
-Determining when you pay tax – limited companies are only liable to pay tax at the end of a tax year, so you can easily determine how much profit the company has made. This is particularly beneficial for seasonal businesses and those with irregular income
-Vehicle savings – you are able to pay less tax on some specified business vehicles if you operate as a limited company
-Privacy – as a sole trader you can retain privacy around your accounts and other details
There is always an element of personal preference involved when determining if you wish to operate as a limited company, as many business owners may wish to take advantage of limited liability status.