Should I set up a limited company or operate as a sole trader? This is one of the first questions that you will encounter when embarking on the journey of becoming an entrepreneur. This article will help you to decide.
Perceived benefits of limited companies
There are several benefits to incorporating (setting up a limited company):
- Increases your chances of securing clients. Some clients are willing to deal with limited companies only.
- Makes your business appear more professional
- Limits your liability to the company and separate from personal assets.
However, some people are deterred by the prospect of additional administration of running a limited company. For this reason alone, they often choose not to incorporate but operate as a sole trader. The next question is – are they missing out?
Compare the tax bills
Let’s leave aside all the above qualitative factors, and compare the tax bills of the two operating models side by side.
Tax | Sole Trader | Limited Company | ||
National insurance contribution | 9% | As low as 0% | ||
Corporation tax | N/A | 19% – 25% | ||
Tax free allowance on income | £12,570 | £12,570 | ||
Income tax rate | 20%/40% (on profit) |
8.75%/33.75% (on dividend) |
||
Tax free allowance on dividends | N/A | £1,000 |
Recently, HMRC has increased the corporation tax rate. For company profit below £50,000, it is still taxed at 19%, but for profit above £50,000, it is tax at a gradually higher rate up to 25%. In addition, it also reduced the dividend allowance from £2,000 to £1,000 and increased dividend rate by 1.25 percentage point on basic rate, higher rate and addition rate. All these changes deminish the benefit of operating a limited company.
Who wins? – It depends!
In summary, after considering all the above factors, you can draw a dividing line – if your business makes less than £30,000 gross profit, operating as a sole trader will maximise your take home pay. If your business makes more than £30,000 gross profit, operating through a limited company will maximise your take home pay. Once your profit surpasses £90,000, it becomes more beneficial to operate as a sole trader again. If you are operating as a limited company and making profit towards it and want to avoid big changes, you can increase the employer pension contribution to reduce corporation tax. Here, gross profit = revenue – all costs excluding your salary. Both scenarios assume that you don’t have any other income. The table below illustrates the difference in take home pay at various profit levels.
Trading Profit | Net income as Limited Company |
Net income as Sole Trader |
Net income differece |
15,000 | 13,903 | 14,134 | (231) |
20,000 | 17,628 | 17,712 | (84) |
30,000 | 25,012 | 24,805 | 207 |
40,000 | 32,396 | 31,898 | 498 |
50,000 | 39,780 | 38,991 | 789 |
60,000 | 47,111 | 44,815 | 2,296 |
70,000 | 52,064 | 50,714 | 1,350 |
80,000 | 56,885 | 56,456 | 429 |
90,000 | 61,705 | 62,198 | (493) |
100,000 | 66,526 | 67,940 | (1,414) |
What if?
What if you have other income? such as employment income, property income. Well, the £30,000 line will apply to the total of your other income and the business gross profit.