Sole trading to limited company. How much tax can you save?

For many self-employed business owners, a welcome increase in annual earnings may also hold important financial questions with regard to their tax liability and tax efficiency.

Despite the advantages of operating as a sole trader, you may quickly realise that the tax costs of sole trading may outweigh its simplified benefits.

In our new guide, we explain why it may be essential to consider incorporating your business as a limited company when your business revenue starts to grow.

Why tax efficiency may decrease while earnings increase?

One of disadvantages of sole-trading, is the lack of flexability it has to offer when it comes to structuring your income and take-home pay.

A taxable income for self-employment will normally be charged at a 20% minimum rate Income Tax, along with any additional National Insurance Tax deductions.

This translates to £1,800 increase in Income Tax with £923 rise in National Insurance Tax, as and when your earnings go up from £30K to £40K, annually.

Below is a simplified calculation of how the increase in sole trading earnings may affect your tax bill and take-home pay.

Annual earnings before tax: £30K
Sole Trader
Expenses	£3,000
Income Received	£27,000
Tax
Income Tax	£2,886
National Insurance	£1,918.60
Total take-home pay after tax	£22,195.40

 

Annual earnings before tax: £40K
Sole Trader
Expenses	£4,000
Income Received	£36,000
Tax
Income Tax	£4,686
National Insurance	£2,841.60
Total take-home pay after tax	£ 28,472.90

Why a limited company might be better option for your growing business?

As a company director, you’d be able to set a smaller portion of your income as Directors’ Salary and significantly reduce any Income Tax liability.

In addition, a director’s income could be paid as dividends and get taxed at a much lower Dividend Tax rate of 8.75%.

With a £30K annual income, you should be £612.87 better off as a limited company shareholder and may see £1,362.12 net rise when your annual income reaches £50K.

	Take-Home Pay
Annual Income	Sole Trader	Limited Company	Annual Benefit
20K	£15,917.90	£16,156.14	£238.24
30K	£22,195.40	£22,808.27	£612.87
40K	£28,472.90	£29,460.39	£987.49
50K	£34,750.40	£36,112.52	£1,362.12
80K	£50,758.00	£53,624.33	£2,866.33

Other specific tax benefits for limited companies

Pre-trading expenses

You can reclaim business expenses incurred during your self-employment period (Once your company has sufficient funds) and up to 7 years prior to when your limited company was registered.

Flat Rate VAT & Limited Cost Traders

IT contractors, consultants or freelancers are usually classed as low expenditure businesses and Limited Cost Traders, with a limited ability to reclaim VAT.

In this case, Flat Rate VAT becomes an attractive solution, as it allows Limited Cost Businesses to pay HMRC a lower tax rate from the 20% VAT they invoice their clients with.

Therefore, you could earn a little extra just by being registered for VAT.

Next step

Your personal circumstances may vary from the guidance provided in this guide, but as your business grows in revenue you should normally expect a rise in tax liabilities as well. It doesn’t mean you have to ‘foot the bill’, though. Advise with your accountant and assess your current tax position. You could quickly realise that incorporating your business may well be the next best step forward.