If you’re a sole trader in the UK making a profit of £25,000 or more, you could probably reap the Benefits of Becoming a Limited Company. Yes, that does mean more HMRC deadlines and a lot of other seemingly scary things, but it could mean significant tax savings and lots of other benefits.
A sole trader is someone who owns a business and is self-employed. A limited company is a business that is separated from its owner as a standalone legal entity.
What does this mean?
It means that a sole trader and their business are classed as the same entity, and the trader could be liable for any debts or problems with their business. On the other hand, a limited company and the owner are separate entities in the eyes of the law. The limited company could be in debt, but the owner may not be.
Sole traders experience unlimited liability for their business, and owners of limited companies experience limited liability. Additionally, there could be tax benefits to switching from operating as a sole trader to the owner of a limited company.
Not everyone can benefit from becoming a limited company, but some sole traders are losing hundreds of pounds each year by not taking the leap. It is always better to speak with the best UK accountants first to see if you can experience the following benefits:
When you are a sole trader, you calculate your profits by taking away costs and expenses from your annual income. These profits are then taxed at your personal tax rate. However, when you are a director of a company, the situation plays out differently.
You can take a wage from the company that is purposely set below the NIC limit, and you can take a tax-free dividend payment of £2,000 each year – and further dividend payments subject to tax rates that are lower than the 20% income tax rate. Moreover, these payments to yourself will be the company’s expenses and will not be subject to corporation tax.
Sounds tricky? Let a UK accountant go through the details and explain how much you could save each year.
Running a limited company adds an element of professionalism to the business. And this can set you apart in the eyes of other businesses and potential customers. In fact, it is known that some companies only like to engage with other limited companies rather than sole traders. You could grow your business and earn more by simply becoming a limited company.
Moreover, some banks will only provide business loans to limited companies and not sole traders.
One of the most used techniques to reduce tax liability as a limited company is to pay family members a wage for work that they do for the business. They must do genuine work for the business to be paid, but you can pay them and add their wages as business expenses, mitigating your tax liabilities over the course of the tax year.
Note, this should be done by the book with genuine family workers.
As discussed earlier, a limited company is a separate entity in the eyes of the law. As a consequence, you remove any business liability from yourself as a limited company as you are just another worker for that company, unlike a sole trader who is 100% responsible for their business (not separate entities).
A limited company can reduce your liability and make operating a business less risky.
A limited company must register their business name on Companies House and no other business can operate with the same name. Sole traders may operate with a business name, but this name is not recognised in law like the names of limited companies.
Therefore, limited companies can secure their name and protect it from other businesses.
Some sole traders decide not to make the potential tax savings because of the hassle of setting up a limited company and any new obligations. Yes, these initial costs could wipe out any savings in the first year, but thereafter, you could be saving lots on your taxes every year after.
Discuss your situation with one of our UK leading accountants and find out what sort of savings you could make!