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Limited company tax vs sole trader tax

Many people make the move from working as a sole trader to running a Limited company for financial reasons. There are a number of ways in which you could save money as a Limited company which aren’t available to you if you are a sole trader, although there is a little extra admin involved. If you are thinking of changing the way you work, or considering starting a business and want to decide which would work best for you, then there are a number of things to be taken into consideration.

Tax as a sole trader

When you decide you want to be self employed, you need to inform HM Revenue and Customs as soon as you can. They will send you out information including a reference number to access their website, which you should keep in a safe place. As a sole trader (or a partnership if you are working with others) you and your business are considered single entities for the purposes of tax and your financial affairs.

Your will be required to submit your tax return once a year, so keeping records throughout the year is a good idea to ensure that you have all your paperwork to hand when it comes to reporting your income to HMRC.

Calculating and paying your tax

The process of becoming a sole trader is relatively simple and registering with HMRC costs nothing and only takes a few minutes. You can register online or over the phone, and the process is easy to complete.

  • You will need to have a few details to hand before you call, such as your National Insurance number, details of your business and a few personal details.
  • Once you have registered, you will be sent a Unique Taxpayer’s Reference number which you will need to submit your tax return when the time comes.
  • When you complete your self-assessment tax return you will need to include details of your income as well as any expenses incurred in the course of your work in order to calculate your total profits.
  • You can file a paper tax return which will need to be submitted by the 31st of October each year, or you can file online which will mean that you don’t have to file until the 31st of January.
  • Your tax will then be calculated for you if you file online, but if you choose to file with a paper tax return then you will need to work it out for yourself, or ask your accountant to calculate it for you.
  • The deadline for paying your tax is also the 31st of January, but it’s best to ensure that you complete the process in good time.
  • If you fail to complete your tax return or pay the tax you owe by the deadline then you will be liable for fines and interest which increase until you pay.

VAT

  • You do not need to register for VAT until your turnover has reached the current threshold, which is £81,000 in 2014/15, but you may decide to do so anyway.
  • VAT registered businesses effectively collect tax on behalf of HMRC by charging their customers VAT, but they can also claim back VAT on any purchases they make.
  • The Flat Rate VAT scheme is a simpler way of dealing with VAT and could help you to save money.
  • If you are registered for VAT you will need to complete a VAT return and keep records to show everything you include on it if needed.

National Insurance

  • As a sole trader you will need to pay Class 2 and Class 4 National Insurance Contributions.
  • You will usually pay Class 2 NICs by direct debit whereas Class 4 NICs are calculated based on your annual income and will be payable through the self-assessment system.
  • In the 2014/15 tax year, Class 2 NICs are £2.75 a week if you are turning a profit of £5,885 or more.
  • For those who are earning less than £5,885 then you can apply for an exemption which will mean you don’t need to pay Class 2 NICs.

Employing staff

  • If you hire staff in your business, you will need to tax them at source by deducting NICs and PAYE tax from their wages.
  • Employer’s Class 1 NICs may be payable on your employees’ wages.
  • You will need to set up a payroll for your company and submit information about this to HMRC.

If you are starting out in business then self employment is often the simplest way to manage your financial affairs, but you will still need to keep detailed and accurate records of all your business’s financial transactions. Having an accountant could help you to understand more about how financial processes work, help you with tax planning and assist you if you do choose to begin trading as a Limited company when you feel it is right for you.

Tax as a Limited Company

Most sole traders who decide to register as a Limited company do so in order to take advantage of the benefits of tax planning and the ability to limit their own liability and enjoy greater security for their own assets. The tax position as a director of a Limited company is a little more complicated than that of a sole trader, but you can make considerable savings through tax planning and paying yourself a minimal salary, instead withdrawing dividends from your company which can also reduce your bills. Setting up a Limited company does incur fees, but you can complete the whole process for £125 for an inclusive package which will provide everything you need for your new business.

You will need to submit tax returns for your business once a year and pay any corporation tax due, as well as personal tax returns for anyone named as a director of the company. You will also need to, pay VAT where applicable, ensure that any employees’ taxes and NICs are paid and submit accounts to Companies House.

Calculating and paying your tax

Whilst many sole traders do use an accountant to help them manage their finances, those who don’t should consider engaging one if they decide to begin trading as a Limited company. There are many things to be considered before registering and an accountant will help you to work out whether you will benefit financially from making the change.

An accountant will also help you to make the most of the tax efficiencies available to you as a Limited company, and they will usually complete your tax returns and compile your accounts at the end of each year.

  • As a small Limited company you will be liable for the ‘small companies rate’ of corporation tax, which is 20% on profits up to a total of £300,000 in 2014/15 and rises as your profits increase.
  • You will need to complete a corporation tax return every year, although your accountant will usually complete this on your behalf.
  • Your corporation tax bill is payable within 9 months and 1 day of the ‘normal due day’ of your company, which is usually a year after the formation of your company.
  • Corporation tax is only due on your profits, so it can be beneficial to identify any expenses which can be deducted from your profits in order to minimise your tax bill such as the set-up costs of your business, travel, accountants fees and more.
  • You can also minimise the level of tax you pay by leaving some of your profits in the company to ensure that you are only paying at the lowest rate – this is particularly helpful if your income fluctuates from one year to the next.
  • You will still have responsibility for your personal tax bill, which you can complete via the self-assessment process.

VAT

  • As a Limited company, you will need to register for VAT if you earn more than £81,000.
  • You will need to collect VAT from your customers at the prevailing rate. You will then need to pay this to HMRC, although you can deduct any VAT you have paid on your business expenses from the total.
  • You can take advantage of the Flat Rate VAT Scheme or the ‘cash’ scheme which allows you to pay HMRC only after you have collected the money from your customers.
  • Your accountant will help you to ascertain which scheme will make most financial sense for you and your business.

National Insurance

  • You will need to set up company payroll to take care of your salary and NIC liabilities.
  • If you have any employees then you will need to set up PAYE and NICs to be deducted at source.
  • These sums will need to be paid to HMRC which can be done on either a quarterly or monthly basis.
  • You will need to let HMRC know if you do not pay any salaries in order to ensure that they are aware that you have no tax or NICs liabilities in any given period.
  • If you choose to pay yourself a salary through your business, you will only be liable for NICs on your salary as dividends do not attract NICs.

Paying into a pension can also help you to make tax savings as you will not be liable for tax on sums paid into a pension plan, so you could save as much as 48% on funds set aside for your retirement.

There are other taxes that you may encounter as a Limited company such as Capital Gains Tax, but your accountant will help you to work out which taxes you may be liable to pay, as well as options to reduce your tax bill.

A little admin, keeping accurate records and consulting with an experienced accountant can help you to reduce your tax bill, plan for your company’s future and make decisions which will reap benefits for your business in the long term. Seeking expert financial advice will help you to ensure that you take home as much of your profit as possible and help you to make sure you fulfil all your obligations, whilst protecting you against incurring any unexpected costs. 

If you would like some more advice on the differences between Limited company tax and sole trader tax, please call one of our friendly accountants on 01442 275767or email newbusiness@easyaccountancy.co.uk

If you are thinking about making the move to self employment, you might find the following pages useful:

Why Clients Choose Easy Accountancy

Easy Accountancy offers a low cost, fixed fee accountancy package with all clients receiving their own dedicated, friendly, approachable accountant.

All of our accountants specialise in providing accountancy services to the self-employed, freelancers, sole traders, small to medium sized limited companies and private individuals. All accountants are employees of Easy Accountancy and we never outsource or offshore work.

Our low cost, all-inclusive fixed-fee accountancy service includes unlimited access to your own dedicated accountant throughout the year and covers all your business and personal tax affairs needs.

All our accountancy services include:
  - Unlimited access to your accountant
  - Ongoing advice on how to manage your business
  - Proactive tax advice throughout the year
  - Updates and reminders so you'll never miss a deadline
  - Free bookkeeping software

As a sole trader our fees start at just £60 + VAT a month, for this you receive the above plus:
  - Completion of your Self-Assessment tax return
  - Advice on how much Income Tax to pay
  - Guidance on National Insurance contributions

As a limited company our fixed fee packages are bespoke to your needs, however typically you’ll receive the above, plus:
  - Completion of your year end accounts*
  - Completion and submission of your annual return Companies House
  - The director/s Self Assessment tax return
  - Payroll bureau
  - Dividends and corporation tax computations

We’ve saved our clients up to half on their accountancy bills – if you’d like a quote, click on the quote me button to the right of this page. Alternatively, call us on 01442 275767 or email newbusiness@easyaccountancy.co.uk.

*If you would like us to complete your company year end accounts we simply ask that you have been a client of Easy Accountancy for one year or have made 12 monthly payments.