Registering your business as a limited company can reduce your tax liability and save you money. But getting paid through a limited company is slightly more complicated than being a sole trader.
Here's a look at the ins and outs of taxation for limited companies.
Unlike sole traders, limited companies don't pay income tax and National Insurance. Instead, they pay corporation tax on their profits (income less allowable expenses). The current rate is 19 percent.
Corporation tax doesn't include a tax-free allowance. Nor do different rates apply depending on how much you earn. It's a straight up 19 percent deduction.
Let's say your limited company earns £100,000 in 2017/18. Your expenses total £30,000, which means you've made a profit of £70,000.
Your corporation tax liability would be 19 percent of £70,000. Or £13,300.
The law considers a limited liability company to be a separate person. Any money you earn from your business belongs to the company, and you can't withdraw it from the company bank account whenever you please. To get paid, you'll need to take a salary or declare a dividend.
To take a salary through your limited liability company:
The company can deduct your salary from its profits as a business expense. But you may have to pay personal income tax and National Insurance. Depending on your salary, your company may also have to pay employers' National Insurance on your behalf.
You can avoid income tax and National Insurance by paying yourself just below the threshold for National Insurance. In 2018/19, this is £8,424 a year. This amount:
Of course, £8,424 a year probably won't be enough for you to live comfortably. And that is where a dividend comes in.
A dividend is a share of the company's profits, paid to its shareholders. ‘Shareholder' is the legal term for a person who owns all or part of a company (read: you).
To take a dividend:
Because paid out of profits after tax, a dividend doesn't affect your company's tax position. On the other hand, you won't be surprised to hear that it affects your personal tax liability.
There is no change to dividend tax rates in 2019/20.
Dividend tax rates are much lower than income tax rates, so it can be tempting not to take a salary at all. Postponing your earnings isn't customarily a good idea.
For starters, not taking a salary means you'll fall outside the lower earnings limit. As a result, you won't qualify for the benefits of National Insurance, including a state pension. More importantly, not taking a salary could attract HMRC's attention, which is something that's always best avoided.
It's usually best to speak to a qualified accountant before deciding how to take money out of your limited company. A seasoned accountant who stays current with the tax laws is someone to heed.