April 11, 2019 Limited company and sole trader differences 2019/20 In this article we are going to discuss the main differences for the 2019/20 tax year between running your business as a sole trader in comparison to a limited company, in general terms and then in regard to UK taxation (the article assumes you are a taxpayer in England and Wales). What is a sole trader? Many businesses start life as sole traders, this is often referred to as being self-employed. The benefits of starting up as self employed is the relative simplicity in setting up the business and the general administration is less onerous than trading as a limited company. To start up as self employed, as far as tax is concerned, it is simply a case of letting HMRC know you are now self employed, you can do this fairly easily via HMRC’s website on the link below: https://www.gov.uk/log-in-file-self-assessment-tax-return/register-if-youre-self-employed Going forwards the sole trader then needs to prepare a self assessment tax return once a year declaring income and expenses of the business on the self employment pages and paying the necessary tax and national insurance on the profits of the business (more about that later). As a sole trader there is no separation of the business assets and liabilities from your own personal assets and liabilities, therefore all profits are taxed on you as an individual regardless as to whether you have left any funds in the business or not. Furthermore, should the business run into financial difficulty or face legal action you would find yourself personally responsible and any personal assets you own could be at risk. Trading as a limited company In contrast to trading as self employed, running your business via a limited company offers limited liability status as the company is considered a separate legal entity to yourself. As such, so long as no illegal activity has taken place and the company is complying with company law obligations, the liability of the business owner is limited to the amount they have paid for their shares in the company – this is often a very small amount in small / micro businesses. However, in order to run a limited company there is more administration involved. Not only will the director(s) / shareholder(s) need to declare any income they extract from the company by way of a salary and/or dividends on their own personal tax returns, but the company will need to prepare company accounts on an annual basis. These accounts will need to be filed with Companies House and kept on public record. The company will also need to file an annual corporation tax return and full accounts with HMRC and pay any corporation tax liabilities within 9 months after the company year end. Furthermore, there is a requirement to file a confirmation statement (this used to be called an annual return) advising companies house of any changes in directorships, shareholdings or addresses in the year in question. These details will also be kept on public record. Some businesses wish to trade as a limited company for an element of prestige – limited company status can often make the business appear to be a larger operation than that of a sole-trader. Tax – sole trader As a sole trader for the 2019/20 tax year there is personal tax and two types of national insurance that are payable (class 2 and class 4). You do not start paying tax until your total income (self employed profits plus any other taxable income) exceeds the personal allowance of £12,500 for 2019/20. After this threshold, tax is charged at the following rates (for England and Wales): Profits between £ Tax Rate 12,500-50,000 20% 50,000-150,000 40% 150,000+ 45% Note, the above rates are ignoring the removal of the personal allowance between £100,000 and £125,000. As far as national insurance is concerned, this is charged at the following rates: Class 2: £3 per week when profits are over £6,365 Class 4: Profits between £ National Insurance Rate 0-8,632 0% 8,632-50,000 9% 50,000+ 2% As an example, using the above rates, at a level of self employed profits of £50,000, you would pay the following amounts to HMRC for the 2019/20 tax year: Tax £7,500 Class 2 NI £156 Class 4 NI £3,723 Total payable HMRC £11,379 The above would need to be paid to HMRC by 31st January 2021 (ignoring any past or future payments on account). Tax – limited company A limited company is taxed very differently to that of a self employed individual. All profits of the company are taxed at 19% (19/20 rate). The individual director / shareholder is then taxed personally based on how much they extract from the company. Where the only stream of income for the director / shareholder is from the company the extractions, in order to be as tax efficient as possible, usually take the form of a small salary with the remainder in dividends – see our article below which discusses the best combination of salary and dividends for the 2019/20 tax year: Optimum Salary and Dividends 2019/20 Salaries are taxed in the same way as self employed profits, however with a small salary taken of £8,580 (as per Option 2 in our article above) no tax or national insurance would be payable on this amount. Dividends are taxed at the following rates and do not attract national insurance: Dividends Tax Rate Within the personal allowance (£12,500) 0% Within the £2,000 dividend allowance 0% Between £14,500 and £50,000 7.5% £50,000 – £150,000 32.5% £150,000+ 38.1% As such, a director/shareholder of a company with profits of £50,000 extracting all profits after corporation tax by way of optimal salary and dividends would pay the following to HMRC: Corporation Tax £7,870 Tax on Dividends £2,072 Total payable to HMRC £9,942 Tax saving as a limited company £1,437 Sole trader vs limited company tax calculations: The tax savings by trading as a limited company at various levels of profit for the 2019/20 tax year are as follows: As you can see the tax saving of trading as a limited company in comparison to self employment continues at all levels of profit illustrated. It reaches its peak saving at profits of £60,000 and starts to save less after this point. This is due to the extra tax that is payable on dividends in the higher rates. One of the big savings when trading as a limited company is where you do not need to extract all the profits. At a profit level of £100,000 you have no option as a sole trader other than to pay the £32,379 shown above. As a limited company, if you are comfortable taking only salary and dividends up to the higher rate threshold (a personal extraction of £50,000) the total tax payable is £20,033 a total saving of £12,346 in comparison to that of a sole trader. However bear in mind that the above savings do not consider the extra administration costs of running a limited company. Overall it can be seen that from a pure tax point of view limited company status can be beneficial. However, many businesses have more nuanced situations and before deciding to trade as a limited company it is strongly advised that you speak to an appropriately qualified and experienced accountant to discuss your specific circumstances. It is worth bearing in mind that there are some specific rules when it comes to the differences as to what expenses can be claimed through a limited company compared to that of a sole trader – for example see our article about travel expenses for limited companies. This article is only meant as a brief introduction to the topic and there are many tax planning issues that we have not covered that could affect your own circumstances.