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If you’re freelancing full-time that means you have probably had to deal with something we all dread – taxes. During Tax Week Chartered Accountant and Managing Director Elaine Clark will be offering some advice to everyone. 

Tax expert Elaine Clark

Whilst sorting out the tax and accounts is probably the last thing on your ‘To Do’ list, unfortunately it is an essential part of our day to day tasks, especially in the present climate of continuing clamps downs and task forces announced by HMRC almost on a daily basis. I know, the world of tax and accounts can be a complete minefield.

Even at the outset, making the choice on your business structure can be a complex decision.

Should you set up as a self-employed freelancer or as a limited company?

From April this year the tax paid by small limited companies (corporation tax) is the same as the basic rate of income tax – 20%.

In addition, the increase of self-employed National Insurance should prompt those operating as self-employed freelancers to review their business structures for potential tax savings.

What do you think of when you think of taxes?

Why are you a self-employed?

Maybe you decided to be a self employed sole-trader as there was less formality and paper work involved in the set up.

Maybe you didn’t realise that there was an option!

The decision on your appropriate business structure is not an easy one – it certainly isn’t a ‘one size fits all’ answer.

Your personal circumstances should determine your choice and only you can decide on the best structure for you.

Putting aside the misleading perception that a limited company gives you greater status or credibility then, in my opinion, there are two major issues to consider in deciding your business structure:

Limited or Unlimited Liability

As a sole trader there is no distinction between you and your business, you do not need to have a separate business bank account.

However, all the debts of the business are your debts.

If the assets of the business do not cover the debts then your personal assets could be used to pay the debts – including your house!

In contrast, the debts of a limited company belong to the company, which is a separate legal entity.

Except in cases where personal guarantees have been given, your personal assets will not be used to pay the debts of the company.

Tax

The second reason for a limited liability business is based on tax savings.

Tax as a Sole Trader

As a sole trader you pay the following:

• income tax on profits over your personal allowance, assuming no other income
• Class 2 National Insurance at £2.50 / week
• Class 4 National Insurance on profits over £7,225 at a rate of 9% up to £42,475 and 2% thereafter

If your profits are below the personal allowance of £7,475 then in all likelihood it would be better to operate as a sole trader.

You will pay no income tax and will only pay a very small amount of class 4 national insurance if your profits are over £7,225.

If you profits are below £5,315 then you can also apply for an exemption to class 2 National Insurance.

Tax as a Limited Company

A limited company pays corporation tax at 20% on its profits (up to £300,000 where the rate rises).

Profits can be withdrawn from the company by way of a salary for the director(s) and dividends for shareholders. Again this assumes that the directors / shareholders have no other income.

So which is best?

This can be shown by an example…

Say your business has profits of £15,000

You have no other income

Tax as a sole trader would be:

Income tax (£15,000 – 7,475) at 20% = £1,505

Class 2 National Insurance (£2.50 x 52) = £130

Class 4 National Insurance (£15,000 – 7,225) at 9% = £700 (rounded)

Total tax = £2,335

So profits after tax are £12,665

Tax as a limited company would be:

First of all you would pay yourself a small salary at a rate where there is no tax or national insurance but at a rate where you get credits towards your state pension and other benefits.

So, you would pay a salary of £589 / month = £7,068

Your salary is an allowable expense from the profit.

So,  the profit becomes £15,000 – 7,068 = £7,932

Corporation tax on the profit is 20% = £1,587 (rounded)

The profit of £7,932 is distributed from the company as a dividend and no further income tax is due on the dividend as the total income is below the higher rate threshold!

The total available after tax,  is then the available profits + salary – corporation tax = £13,413

So at profits of £15,000 you would be better off as a limited company to the tune of £748.

Some may argue that this would be wiped out by an increase in accounting fees – I usually respond with “not if you are using CheapAccounting.co.uk” !

If your profits are higher the savings may also increase!

Do bear in mind that these figures look even better the more your profits are …

At profits of £30,000 as a limited company you are better off by over £2,000 and this increases to nearly £4,000 at £45,000 of profits.

One final thing….

Sell your sole trader business to your limited company

There may be the opportunity to sell your sole trader business to your limited company.

In doing this you may realise significant tax savings.

It would be inappropriate of me to give a specific example here as the savings are absolutely dependent upon your circumstances.

So my advice is to get someone to review your circumstances and work out a specific projection for you.

You may be surprised at the result!

As always it is recommended that you get advice specific to your circumstances.

The above are examples only and should only be treated as such.

Why not share your thoughts on the forum? Look out for your FREE downloadable guide ’How to keep your accounts made simple’ this week, kindly donated by Elaine.