What taxes do we have to pay?
The tax implications for sole traders and limited companies in the UK are quite distinct due to the different legal structures of these business types. Here’s a brief overview:
Sole Traders:
- Income Tax: Sole traders pay income tax on their profits, which is the turnover minus allowable expenses. The tax year runs from April 6th to April 5th of the following year.
- National Insurance: They are also required to pay Class 2 and Class 4 National Insurance contributions.
- Personal Allowance: There is a tax-free personal allowance, which is currently £12,570 for the 2023/24 tax year.
- Tax Bands: Income above the personal allowance and up to £50,270 is taxed at the basic rate of 20%, and income between £50,271 and £150,000 is taxed at the higher rate of 40%.
Income Tax: Simple breakdown for 2023/2024 tax year, these bands are:
- £0 to £12,570: 0% (Personal Allowance)
- £12,571 to £50,270: 20% (Basic Rate)
- £50,271 to £125,140: 40% (Higher Rate)
- Above £125,140: 45% (Additional Rate)
National Insurance: Simple breakdown for 2023/2024 tax year:
- Class 2 NICs: £3.45 per week if profits are above £12,570.
- Class 4 NICs: 9% on profits between £12,570 and £50,270, and 2% on profits above £50,270.
Limited Companies:
Corporation Tax: The company pays Corporation Tax on its profits. For the 2023/2024 tax year, the Corporation Tax rate is 25% on profits above £50,000 and 19% on profits below £50,000. There is a tapered rate for profits between £50,000 and £250,000.
Dividends: The director-shareholder can extract income as dividends, which are taxed at the following rates:
- £0 to £1,000 (Dividend Allowance): 0%
- £1,001 to £50,270: 8.75% (Basic Rate)
- £50,271 to £125,140: 33.75% (Higher Rate)
- Above £125,140: 39.35% (Additional Rate)
Salary: Directors can pay themselves a salary, which is subject to Income Tax and NICs. However, if the salary is below the personal allowance and NIC thresholds (typically around £12,570), no income tax or NIC is due on it.
Scenario Examples
Let’s compare a sole trader vs a limited company scenario with a business making £70,000 in annual profit.
Scenario 1: Sole Trader
1. Income Tax:
£0 to £12,570: 0% (personal allowance) → £0 tax.
£12,571 to £50,270: 20% on £37,700 → £7,540 tax.
£50,271 to £70,000: 40% on £19,730 → £7,892 tax.
Total Income Tax: £7,540 + £7,892 = £15,432.
2. National Insurance:
Class 2 NICs: £3.45 per week → £179.40 per year.
Class 4 NICs:
9% on £37,700 = £3,393.
2% on £19,730 = £394.60.
Total NICs: £179.40 + £3,393 + £394.60 = £3,967.
Total Tax (Income Tax + NICs): £15,432 (Income Tax) + £3,967 (NICs) = £19,399 total tax.
Scenario 2: Limited Company
Assume the director takes a salary of £12,570 and the remaining profit is extracted as dividends.
1. Corporation Tax: Profit before salary: £70,000 − £12,570 = £57,430. Corporation Tax at 19% on £57,430 = £10,911.70.
Remaining profit after Corporation Tax = £57,430 − £10,911.70 = £46,518.30.
2. Dividends: Dividends after Corporation Tax = £46,518.30.
Dividend Tax:
£0 to £1,000: 0% → £0 tax.
£1,001 to £37,700 (basic rate): 8.75% on £36,700 = £3,211.25 tax.
Remaining £8,818.30 taxed at 33.75% (higher rate): £2,975.68 tax.
Total Dividend Tax: £3,211.25 + £2,975.68 = £6,186.93.
3. Total Tax (Corporation Tax + Dividend Tax): Corporation Tax: £10,911.70. Dividend Tax: £6,186.93.
Total Tax: £10,911.70 + £6,186.93 = £17,098.63 total tax.
Comparison: Sole Trader vs Ltd
In this example, running the business as a limited company would save approximately £2,300 in taxes compared to being a sole trader.
Additional Considerations
- Administrative Costs: A limited company has more administrative costs (accounting, filing, etc.), which can offset some of the tax savings.
- Flexibility: A limited company gives more flexibility in income extraction (salary vs dividends) and may provide other tax advantages, such as pension contributions and allowable expenses.
- NICs: Limited companies can reduce National Insurance Contributions by taking a salary below the NIC threshold and paying the rest as dividends.
It’s important to note that these tax rates and allowances are subject to change and can be updated in each budget. Therefore, it’s advisable to check the latest rates on the official government website or consult with a tax professional for the most current information.
