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Where Taxpayers and Advisers Meet

sole trader vs incorporation for tax purposes does it make sense?

daed
Posts:4
Joined:Thu Dec 11, 2008 9:35 pm
sole trader vs incorporation for tax purposes does it make sense?

Postby daed » Wed Sep 08, 2021 3:38 pm

Hi

If I am a sole trader that has income of £50k I would pay tax of £7486 (20% of 37430 after personal allowance) (not including National insurance for simplicity)

If I form a company instead and have income of £50k and pay myself a wage of £8,840 leaving £41160 to be taxed at a corporation tax rate of 19% I would pay corporation tax of £7820.
This is already more tax than I would pay as a sole trader, even if I paid out the resulting company net profit of £33340 as dividend and paid dividend tax of 7.5% (£2070) on £27610 of it (after last of personal allowance and dividend allowance is deducted)
my total tax would be £9890 (corporation tax + dividend tax)

If I had even higher levels of income say £500k then it would be even worse from what I can fathom because a sole trader would pay 45% on most of it (additional income tax rate) vs 57.1 for a company (38.1 additional divided tax rate + 19% corporation tax)

Given that incorporation entails double taxation (corporation tax then dividend tax) on my income, would it not make sense to stay as a sole trader forever no matter how much I earn or am I missing something here. I keep reading about how forming a LLC could reduce my tax burden but from my simple calculations It seems it would increase it not lower it.

bd6759
Posts:3745
Joined:Sat Feb 01, 2014 3:26 pm

Re: sole trader vs incorporation for tax purposes does it make sense?

Postby bd6759 » Wed Sep 08, 2021 11:00 pm

Maybe not including national insurance has distorted your calculations?

daed
Posts:4
Joined:Thu Dec 11, 2008 9:35 pm

Re: sole trader vs incorporation for tax purposes does it make sense?

Postby daed » Wed Sep 08, 2021 11:59 pm

you are correct that paying 9% national insurance would bump up my total tax if I was earning £50k.

However national insurance is only 2% above £50,270 so If I was earning £500k it would still be 47% total tax for sole trader vs 57.1 for a company would it not?

robbob
Posts:3210
Joined:Wed Aug 06, 2008 4:01 pm

Re: sole trader vs incorporation for tax purposes does it make sense?

Postby robbob » Thu Sep 09, 2021 9:08 am

However national insurance is only 2% above £50,270 so If I was earning £500k it would still be 47% total tax for sole trader vs 57.1 for a company would it not?
You are right it is a mixed bag and ultimately tax can swing back in favour of sole trader as you say when ni drops to 2%

Note if you go the full hog and factor in full lifetime use of funds aligned with pension planning the limited company format can blow the sole trader out of the water at present if for example you make £120k profit - live on 50k cash (possible more if you have spiuse sharholder / employee blah) - add decent wad into pension and leave excess in company to worry about later. Basically higher rate tax need never be paid if your cash needs are moderate and you arent into the millions retained earnings wise.

Ie can you avoid the automatic higher rate tax that applies as sole trsader "if you dont need that cash" and can manage to avoid higher rate tax.
Company format is perfect in that if you earn 40k profit that would be taxed at higher rate as sole trader your company can add all that into your pension (subject to pension limits etc take IFA advise blah) and full sum earned ends up in your pension pot. When you add to pension as sole trader you don''t get any NI reduction so are losing out on the 2%/9% NI you are paying on your tax return.

Another big saving at present is the mismatch on where higher rate tax kicks in!

If your sole trader profit is 58840 - you are nearly 9k into higher rate tax
For limited company at same equivalent profit level - your company will pay £9500 copr tax and your withdrawals IF ALL extracted will be below 50k therefore avoiding ANY higher rate tax - thats a very material saving compared to the nearly 9k with extra 20% added.

For convenience i have ignored the future increase in corp tax.

daed
Posts:4
Joined:Thu Dec 11, 2008 9:35 pm

Re: sole trader vs incorporation for tax purposes does it make sense?

Postby daed » Sat Oct 02, 2021 11:52 am

thanks for info, you are right that it swings in roundabouts depending on exactly how much I earn and how much I want to pay into a retirement fund.


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