One of the most common questions asked by solopreneurs / small business owners is: “Should I be self-employed or incorporate as a limited company?
It is often the case that a freelancer / sole trader starts a business and the business grows such that the matter of incorporation needs to be considered. Although the decision to incorporate should be for commercial reasons rather than tax savings, any tax savings that may result need to be factored into the decision.
Income tax savings
The table below shows the amount of income gained on incorporation (2020/21):
| Profit | Sole trader net income after tax & NIC | Company owner net income after tax & NIC | Savings |
| £20,000 | £17,306 | £17,660 | £273 |
| £30,000 | £24,496 | £25,161 | £665 |
| £40,000 | £31,596 | £32,654 | £1,058 |
| £50,000 | £38,696 | £40,146 | £1,450 |
| £60,000 | £44,496 | £47,557 | £3,061 |
| £70,000 | £50,296 | £53,025 | £2,729 |
| £80,000 | £56,096 | £58,492 | £2,896 |
| £90,000 | £61,896 | £63,960 | £2,064 |
| £100,000 | £67,696 | £69,427 | £1,731 |
| £125,000 | £77,196 | £82,613 | £5,417 |
| £150,000 | £91,696 | £91,915 | £219 |
| £200,000 | £118,196 | £118,084 | -£112 |
From the figures above, it is easy to conclude that considering whether to incorporate or not from a purely tax savings point of view for profits under, say £40,000, incorporation is not worthwhile bearing in mind the additional work and costs involved in preparing more detailed accounts, running a payroll and submitting additional returns to both Companies House and HMRC.
However, reach a profit £60,000 and the situation changes dramatically for incorporation. Greater than £60,000 and the amount of additional income starts to be less inviting becoming nearly completely diminished at £150,000; this is due to the extra tax that is payable on company dividends in the higher rates and reflects gradual disappearance of the personal allowance at income of £100,000.
Other reasons impacting the decision to trade as a limited company
One of the attractive reasons why many small business owners decide to incorporate irrespectively of the tax savings is a greater level of control over their personal tax bill. As a sole trader, you have no choice whether or not you pay tax on all your earnings: the income tax and National Insurance contributions due will be calculated on the whole lot of profits you made during a tax year. If you trade as a limited company however, you can choose how much profit you want (or need) to extract from your business as a combination of a salary and dividends. For example, if the company had, say £70,000 of profits available for distribution, the owner may choose to take out only £50,000 leaving the remaining £20,000 in the company reserves. This way, the owner’s personal tax bill is going to be calculated at the basic rate, whereas the built-up company reserves can be extracted in the following years, or at the end of the company’s life when they can qualify for Entrepreneurs’ Relief.
Another reason for incorporation (and a very important one!) is a degree of separation between business owners / shareholders / directors and the company. Once it has been incorporated, the business becomes a separate legal entity from its owners. That means the finances and assets of the owner / director and the finances and assets of the company are completely separate. If the company is sued or cannot pay its debts, the owners are only liable for the debt to the value of the money they have already invested in the business.
As we all know, life is multifaceted. For some people, it is just more convenient to build a business as a limited company. It might be that the business is a “side hustle” for the owner alongside his or her full- or part-time employment and, for a variety of reasons, it can make more sense to either keep all the profits in the company (for example, to build a savings pot for the future) or not let any potential losses upset their household’s financial situation.
If you are at a crossroads about whether to incorporate your business or not, get in touch and we will help you decide what’s best based on your individual circumstances.