Tax, you can’t avoid it. If you are a business owner tax and your self-employed business is something you consider. If you don’t take tax into account, ‘bites and arses’ will figure somewhere.
Today’s blog will talk about the tax and your self employed business.
In last week’s show, we talked self-employment, what it means, and the business structure options you can choose?
Self-employment means fundamentally working for yourself, you are your boss, you are the owner of your business, you’re the one who gives yourself instructions. You’re the one who ultimately carries the can. If it all goes wrong, your logging ultimately benefits your full goes rights. You set your own direction, you set your own map there as well. And that’s self-employment can be carried out as we saw last week, in a number of different ways.
Sole trader vs limited companies
There are approximately 3.5 million sole traders and 1.9 million limited companies in the UK alone.
It seems right to look at these two ways when we look at Tax and your self-employed business, partnerships get a look in.
Viewpoint
Let’ start with the three different ways your self employed business is viewed
- Accounting
- Legal
- Tax
Accounting
When financial statements are prepared for your business, it should focus on business activity, and excludes personal transactions.
The financial results, whether a company or a sole trader, is fundamentally for the business activity.
Legal
Your accounts should be about your business activity. The law takes a different view , and your sole trader business and you are one of the same.
Money withdrawn for personal use are not wages from a tax perspective, they are drawings. If something goes wrong, and shit hits the fan then you are legally liable for any debts, and mistakes and errors made
If your business is a company then in legal terms two separate now identities exist. Owners, those who have shares in your business are the shareholders. And if you, or others d work for your company, then you will be the directors.
Tax
The tax treatment follows the legal treatment. For your sole trader business, the tax profits are your income, seen as the equivalent of your salary. That is what is taxed, whether you spent it that profit, or left it in your bank account.
Where your business is a company, there are two tax slices taken form the profit cake. Slice number one is the corporation tax on the company. The second tax slice is money paid to you as the individual owner.
It is the second slice that typically comes to you in one of two ways. Salary is what is paid out via PAYE. Dividends, like drawings for a sole trader do not count as a business tax deduction. But if you get dividends then you are likely to pay tax as an individual.
For looking at tax and self-employment we need to look at the whole picture. Read further to check out some numbers.
Differing Taxes
Before to get to the numbers let us thrown in some names for the taxes
Income Tax
For example, income tax is paid on
- Sole trader (and partnership) profits
- Dividends
National Insurance
For example, National Insurance is paid on
- Sole trader (and partnership) profits
- Salaries and wages (employer, employee and directors
National Insurance is often overlooked, but it should not be.
Corporation Tax
For example, corporation tax is paid on
- Salary
- Business profits
This is paid on company profits, remember that dividends don’t count as business costs
Free Tax
This sounds weird but HMRC only charges Income Tax and National Insurance over a certain level, below that it is tax free. If life was simple, they would be the same level, but who wants a simple life! Companies pay tax on all business profits, so nothing tax free there, but the rates are less than for sole trader.
Numbers
Drum roll, we are coming to the end, the numbers part and how you decide what works better for you. Let me share some assumptions, and a warning!
Assumptions
- For companies I have assumed all profits, after corporation tax are taken out as dividends.
- You do not have any additional businesses or money coming from elsewhere
- Two levels of profit, £50,000 (basic rate limit) and £100,000 profits
- The additional costs, like accounting fees, for running a company have not been included. To do so is like asking how long a piece of string is? If you want to know what those extra costs are then contact us to find out
Warning
Legal spiel first. The numbers are guidance, though a rather good illustration. If you rely on this without first talking to an expert first and getting specific advice(subtle hint), then that is a bit bonkers. You are on your own, and I take no legal responsibility!
Having told you my main assumptions let;s see what the numbers say about Tax and your self-employed business.
Tax and your self-employed business
| Sole Trader | Limited Company | Sole Trader | Limited Company | |
|---|---|---|---|---|
| Profits | £50,000 | £50,000 | £100,000 | £100,000 |
| Salary | £10,000 | £10,000 | ||
| Dividends | £32,344 | £72,844 | ||
| Personal take home | £38,855 | £40,196 | £67,855 | £69,447 |
| Difference - £ | £1,341 | £1,592 | ||
| Difference - % | 3.5% | 2.3% |
Conclusion
Firstly, when profits are the £50,000 profit level, you are a basic rate taxpayer. In conclusion, the difference is just over £1,300 pounds, or 3.5% in favour of a company.
Secondly, when profits are the £100,000 profit level, you are a higher rate taxpayer. In conclusion, the difference is just under £1,600 pounds, or 2.3% in favour of a company..
Certainly, you might be thinking that it’s not a massive difference. But read on.
- Most importantly the company scenario is based on all post-tax profits taken out as dividends. To clarify. this is not something I would generally advise (see legal spiel above).
- The less dividends you take, the more tax you save
- You have got more control of how much, and when to take it out
- More opportunities for favourable tax planning for your company, and you.
There are differences between the treatment of Tax and your self-employed business. This blog gives a sense of the differences, and opportunities. The tax question may seem confusing, after this blog, hopefully less so.
Get in touch with us to find out more about limited companies, sole traders, and business tax. For more business and finance , news, advice and tips, don’t forget to watch our weekly broadcasts, listen to our weekly podcast I Hate Numbers.