"Should I set up a limited company?" is one of the questions we are asked most. The honest answer is that it depends. A company can save tax for some people, but it also brings more admin, more cost and more rules.
This post explains the main differences, so you can see which way you lean before we look at your figures.
How a sole trader is taxed
As a sole trader, you and the business are the same for tax. You pay tax on your profit, whether you take the money out or not.
Income Tax at 20%, 40% or 45%, after your £12,570 personal allowance (Scotland has different rates).
Class 4 National Insurance at 6% on profits between £12,570 and £50,270, and 2% above that.
You report everything on one Self Assessment tax return each year.
How a limited company is taxed
A company is a separate legal person. It pays its own tax, and you pay tax on what you take out.
Corporation Tax on the company's profit: 19% on profits up to £50,000, rising to 25% on profits over £250,000, with marginal relief in between. These limits are for a 12-month year with no associated companies.
Salary for you as a director. Salary is a cost for the company, but it can mean Income Tax and National Insurance for you and employer National Insurance for the company.
Dividends paid from profits after Corporation Tax. The first £500 is tax free, although it still uses up part of your tax band. After that, dividend tax is 8.75%, 33.75% or 39.35%, depending on your tax band. A company can only pay dividends from profits it has available, after any past losses.
Many directors take a small salary and the rest as dividends. Profit you leave in the company is taxed only at Corporation Tax rates. Dividends paid from those profits may then be taxed on you as well. Salary is different: it is a cost for the company, so it reduces the company's taxable profit.
Other differences
Liability. A company's debts are usually its own, so your personal assets are better protected. In practice, banks and landlords often ask directors for a personal guarantee.
Admin. A company files annual accounts and a confirmation statement with Companies House, and a Corporation Tax return with HMRC. If you pay yourself a salary, you also run a payroll. Accountancy fees are usually higher.
Privacy. Company details, accounts and directors' names are on the public Companies House register.
The money. Company money belongs to the company. Salary, dividends and director's loans each have their own rules. If you lent money to the company, it can normally repay you without any tax.
Image. Some clients and larger customers prefer to deal with a limited company.
When each one tends to suit
A sole trader often suits you if:
you are just starting out or your profits are modest
you need to take out most of what you earn to live on
you want simple records and lower costs
A limited company often suits you if:
your profits are higher and you don't need to take it all out each year
you want to limit your personal risk
your clients expect to work with a company
you plan to grow, take on staff or bring in other owners
You can start as a sole trader and move to a company later. The switch has its own tax points, so plan it with your accountant.
Summary
There is no single right answer. A company can save tax once profits are higher, but it costs more to run and comes with more rules. A sole trader is simpler and often right for smaller or newer businesses.
If you would like us to compare the figures for your business, book a call or contact us.