If you are thinking about doing freelance work but would like to set up your own limited company to do it, then most accountants would agree that this is the most tax efficient way to work. However, running a limited company rather than working as a sole trader can seem a bit of a daunting prospect with the additional paperwork and administrative demands.
Limited company taxes are indeed more complicated but very often people are put off by the terms and jargon used. Don’t let the complexities put your off from forming your own limited company as there are some clear benefits to your income, so it is worth investigating to see if this is the right option for you.
For an illustrated version of our top tax tips for the self employed and small businesses, please click on the below image.
To try and help you plough through the jargon, we have put together this simple guide to make it as easy to understand as possible. Here are some of the key terms you will encounter:
Limited Company Tax
If you are moving from being a sole trader to a limited company, the easiest way to think about tax is to consider the company and you as the owner (and employee) as two separate entities. It can make things clearer to separate the two in your head, as limited company taxes will be different to the taxes on your own salary or personal income, whereas for most sole traders the two are one and the same.
Corporation Tax is the tax that all limited companies are required to pay on profits. For small businesses with less than £300,000 a year in annual profit, the current Corporation Tax rate is 20 per cent. Note that these profits do not include your own salary for the year, as you are classed as an employee and therefore a company ‘expense’. So if you billed your clients £200,000 plus VAT over the course of the year and have deducted expenses including your salary of £30,000, then you will have to pay the 20 per cent Corporation Tax on the remaining £170,000.
Employer's National Insurance Contributions
Companies are required to pay National Insurance Contributions on behalf of all employees who are paid more than the current threshold of £149 a week. The current rate that companies pay is 13.8 per cent.
Value Added Tax (VAT)
If you’re revenue is over £79,000 a year then you will be required to register for VAT, or if it is below that then you may choose to voluntarily register for VAT. The current rate of VAT for most goods and services is 20 per cent, so if your company is VAT registered then you will need to add this to all bills and invoices to clients. That money collected is then handed back to HRMC on a quarterly basis.
If you do not buy a lot of stock or make many VAT chargeable purchases throughout the year, then your company can also sign up for the Flat Rate VAT Scheme, allowing for simpler VAT returns but also helping you to increase the company revenue by collecting VAT at 20 per cent and then paying back HMRC a lower flat rate of VAT and keeping the difference. For example, in the first year of trading an IT contractor would charge 20 per cent VAT on a £1,000 (£200) invoice but only have to pay HMRC back 13.5 per cent (£135), so the company would keep the £65 difference. This is then counted at profit so would be taken into account when working out how much Corporation Tax you pay, but it still can add up to thousands of pounds a year in additional income for many small businesses.
PAYE and Income Tax
If you are running your business as a limited company then you will most likely be drawing earnings from the company in two ways, both as a salary as an employee and also as dividends in your capacity as director.
This can complicate things slightly when working out your tax liabilities, as both types of income are taxed differently.
Your salary is taxed through PAYE (pay as you earn), the same as if you were working for another company. Once your salary is above the tax-free personal allowance, £9,440, then your earnings will be taxed at the standard rate of 20 per cent. Earnings above £32,010 will be taxed at the higher rate of 40 per cent, with a 45 per cent tax rate applied to those earning above £150,000.
Higher salary earners will also see their personal tax free allowance reduced once their salary tops £100,000, with the allowance reducing by £1 for every £2 of earnings.
Dividends are subject to lower tax rates than your salary income. Dividend earnings up to £32,010 will be taxed at 10 per cent, rising to 32.5 per cent once dividend income goes above that threshold, and 37.5 per cent for dividend income above £150,000 a year.
Employee's National Insurance Contribution
National Insurance is paid at a rate of 12 per cent on all salary earnings between £149 a week and £797 a week. For salaries above £797 you will pay just 2 per cent on your earnings above that figure, but still pay 12 per cent on the first £797.
No National Insurance is paid on dividend income.
Limited companies are responsible for paying PAYE income tax and National Insurance contributions every quarter, as with VAT. One of your accountant’s most crucial jobs will be to make sure you meet your deadlines for payments throughout the year.
The rates and thresholds above are often subject to change and can be different from one year to the next, which is another reason why it can be very beneficial to use an accountant as they will stay up to speed with all the changes.
Here is a roundup of the basic liabilities you need to bear in mind for both your company and personal income:
- Corporation tax must be paid nine months and one day after the end of your financial year.
- VAT must be paid every quarter.
- PAYE income tax and National Insurance must be paid every quarter.
Self-assessment on your personal income is due by January 31 every year, while you may also be required to make payments on account (contributions towards future tax bills) by January 31 and also by July 31 every year.
There is no escaping the fact that tax is a complicated subject but we hope the above guide has helped to make things a little clearer. A good accountant will work with you to ensure that they take care of the complex tax issues, leaving you free to build your business.
If you have any further questions about your tax liabilities or would like to find out more about Easy Accountancy’s fixed fee services for small businesses, contact us on 0500 23411 / 01442 275789 or email email@example.com.