Could going limited slash your tax bill?

Reduce tax billThere are many reasons why registering as a limited company or operating as a sole trader works for the self-employed. Each has its advantages, a fact that makes it difficult for contractors and small business owners to decide which route is right for them.

As well as being easy to set up, working as a sole trader means less administration, with your tax and NI obligations fulfilled through the filing an annual Self Assessment tax return. Being a sole trader can provide greater privacy than working as a limited company, with details of incorporated businesses easily found on Companies House. On the other hand sole traders generally portray a less strictly professional image. Finance may be more difficult to raise as a result.

Becoming a limited company has its benefits too, particularly when it comes to managing your finances tax efficiently. Here, we reveal just how much you could save on tax by registering as a limited company.

Your tax obligations as a limited company

Whilst as a sole trader your tax and National Insurance (NI) obligations are no different than that of any person traditionally employed, limited company contractors get the benefit of having their personal and professional finances treated as separate entities. As well as ensuring limited liability, being a limited company is more tax efficient with the right advice and support.

There are a number of tax efficient routes to explore. Taking a low salary but high dividends is the most common approach to increased tax efficiency. Some limited company contractors split their income with their spouse or civil partner for efficiency purposes.

This increased tax efficiency comes at a price though. Limited companies tend to have additional responsibilities that can be time consuming to manage, although having a good accountant can help with this. That being said, keeping more of your profit is a powerful plus point that tends to overrule the inconvenience of additional administration.

You’ll save on National Insurance too

It’s not just tax that’s made more efficient. As a limited company contractor taking a salary and dividends, you can minimise your National Insurance contributions too, as Contractor Calculator  explains:

“Contractors taking a minimum salary circa £8,000 and the balance in dividends will end up paying significantly less combined tax and NICs than contractors paying themselves just a salary. This is because the National Insurance Contributions are minimised. In the limited company scenario, after paying corporation tax at a rate of 20% on the company’s gross profits, a contractor extracting dividends would only have to pay an extra 7.5% tax on the first £27,000 of dividend earnings within basic rate threshold – taking the Dividend Allowance into account. This works out at £2,025. From here it becomes clear that taking the low salary and dividends route is advantageous for maximising net income and minimising tax liabilities.”

In fact, the low salary, high dividends route that can be taken as a limited company contractor means you’ll pay no National Insurance at all.

Don’t forget the VAT

If your turnover is more than £85,000 in a 12-month period, you must register for VAT. Both sole traders and limited company contractors must be VAT-registered if their annual income exceeds this threshold. You can lessen the blow of VAT by passing this cost onto your customers, or reclaiming the VAT you pay on any goods or services you buy on behalf of your business.

Keen to unlock the advantages of going limited for yourself? Read our guide to switching from umbrella to limited.