Will I Pay Less Tax As A Limited Company?

We are often asked by startups, sole traders and partnerships: will I pay less tax as a limited company? Yes, you do, but not in all circumstances. Here we’ll explain how to save tax as a limited company. We’ll look at how tax is calculated, compare sole trader v limited company tax, and explain other ways why it is more tax efficient to be a limited company.

Will i pay less tax as a limited company
Photo by Markus Spiske

How much tax does a limited company pay?

Before working out how to pay less tax as a limited company, we should explain: how much tax does a limited company pay. A company pays tax at between 19% for the smallest companies and up to 25% for the largest companies. The percentage applied to the company’s taxable profit to calculate the corporation tax due. To work out the taxable profit, you start with the profit before tax in the accounts. This is its sales minus costs including salaries but before tax and dividends. This profit is then increased for non-taxable costs like depreciation of equipment. Then decreased for non-taxable income and allowances such as the 100% allowance for buying equipment used by the company. The result is the company’s taxable profit.

The rate of tax is determined by the size of the profits. Effectively the first £50,000 of profits are taxed at 19%. The next £200,000 of profits are taxed at 26.5%. It’s more than 25% so that the total tax paid gradually increases from 19% to 25%. Then anything above £250,000 is taxed at 25%. However, these thresholds are divided by the number of associated companies. So if two companies are owned by the same people, there are 2 associated companies, so the thresholds reduce to £25,000 and £125,000.

How much tax does a sole trader pay?

A sole trader pays tax on his/her profits at the income tax rates, which are 20%, 40% and 45%. Like everyone else a sole trader doesn’t pay tax on the first £12,570 of income. The next £37,700 is taxed at 20%. Then 40% is applied to income between £50,270 and £100,000. The effective tax rate then increases to 60% because the personal allowance is gradually withdrawn between £100,000 and £125,140. Above that income is taxed at 45%.

He/She also pays class 2 National Insurance Contributions (NIC) at a fixed rate of £178 per year unless the profits are less than about £6k. As well as class 4 NIC which is 9% on profits between £12,570 and £50,270 then 2%. The taxable profits are worked out almost the same way as company (see above). A partnership does not pay tax – it’s profits are shared between the partners and that profit is taxed on the partner the same way a sole trader pays tax.

Do you pay less tax as a limited company?

Yes. Simply comparing the rates above, you do pay less as a limited company compared to a sole trader or partnership. A company pays tax at between 19% and 25% which is less than a sole trader at between 20% plus NIC of 9%, and 45% plus NIC of 2%. However, that’s not the full picture unless you intend to leave all of the money in the company. Which of course is one way how to save tax as a limited company. However, most director/shareholders need something to live off!

Extracting funds from a company

It is more tax efficient to be a limited company if directors/shareholders take a small salary of £12,570 plus dividends. The salary is tax-free for the employee but the employer will pay 13.8% NIC on the amount exceeding £9,100. Dividends are the company’s profits paid out to shareholders. The first £1,000 (£500 from 2024/25) of dividends are tax-free. Then they are taxed at 8.75% up to the higher rate threshold of £50,270. Then 33.75% up to £100,000. After that, there’s an effective 53.75% up to £125,140. Then 38.1% above that. So, adding together the corporation tax rates and the dividend rates, brings us close to the sole trader tax and NIC rates.

Will I pay less tax as a limited company or sole trader?

All of that is quite confusing and difficult to compare if you’re trying to work out is it more tax efficient to be a limited company or sole trader. So we’ve crunched the numbers at different profit levels to show how much tax do you save as a limited company. The maximum saving is where dividends are limited to the tax-free allowance.

£10,000 Profit

There’s very little tax to pay at this level so there isn’t much difference between the tax as a limited company v sole trader.

Sole Trader £Company £
Net income9,8219,876
Maximum Saving55

£20,000 Profit

So here you start to see a difference between tax as a limited company v sole trader, due mainly to the lower tax rate for companies. The maximum saving if only a salary of £12,570 and £1,000 of dividends start to become noticeable.

Sole Trader £Company £
Dividend tax405
Net income17,66617,795
Maximum Saving535

£30,000 Profit

Again the main difference is that companies pays less tax than sole traders at 19% compared to 20%. The higher the profit, the more you’ll save by leaving money in the company instead of taking dividends. Where as all of a sole trader’s profits are taxed whether you take them or not.

Sole Trader £Company £
Dividend tax1,114
Net income24,76625,187
Maximum Saving1,535

£40,000 Profit

As above, nothing much has changed in terms of the percentage of tax rates paid by a sole trader or limited company.

Sole Trader £Company £
Dividend tax1,823
Net income31,86632,578
Maximum Saving2,535

£50,000 Profit

As above, nothing much has changed in terms of the percentage of tax rates paid by a limited company or sole trader.

Sole Trader £Company £
Dividend tax2,531
Net income38,96639,969
Maximum Saving3,535

£60,000 Profit

Now it is much more tax efficient to be a limited company than a sole trader. That’s because the higher tax rate for a sole trader has kicked in. But the company is still paying low rates due to the salary reducing its profit. Also, the tax reduces the amount of dividend that can be taken so that it only just creeps into higher rates.

Sole Trader £Company £
Dividend tax3,323
Net income44,80147,278
Maximum Saving5,799

£70,000 Profit

So, we’re past the peak of when you pay less tax as a limited company v sole trader. But it is still more tax efficient to be a limited company. This is because the sole trader NIC rate has dropped to 2%. The company tax in now into the 26.5% band. Also, the dividend rate has increased to 33.75%.

Sole Trader £Company £
Dividend tax5,838
Net income50,60152,214
Maximum Saving7,451

£80,000 Profit

As above, the rates are now higher as company. However, the maximum savings continue to grow. And with more profit there’s more scope to leave money in the company to reduce your dividend tax and pay less tax as a company.

Sole Trader £Company £
Dividend tax8,318
Net income56,40157,084
Maximum Saving9,001

£90,000 Profit

Finally, if you are going to take all of the money out of the business, you now pay less tax as a sole trader. However, with this much profit, paying a little more tax to have all the benefits of trading as company must be worth it.

Sole Trader £Company £
Dividend tax10,799
Net income62,20161,953
Maximum Saving10,551

£100,000 Profit

Again the maximum savings continue to grow but the sole trader pays less tax if all the profits are taken out of the company.

Sole Trader £Company £
Dividend tax13,280
Net income68,00166,823
Maximum Saving12,101

Conclusion: Do I pay less tax as a limited company?

You pay less tax as a limited company v sole trader at all profit levels if you keep enough profit in the company (e.g. £3,500 at £100k). It is also more tax efficient to be a limited company if you take all of the profit out when profits are up to about £87k.

Other ways to save tax as a limited company

Company owners have been hit with increases to dividend tax over the past few years. Now they have a potential corporation tax increase of up to 6%. Company owners with large profits may soon be paying more tax as a limited company compared to a sole trader or partnership. However, there are other ways to save tax by using a company. Also, there are benefits to trading through a company such as protection of your personal assets (home etc), and prestige. Read more about the non-tax benefits of trading as a company here.

Companies save you tax by not taking dividends

Company owners can choose whether or not to take dividends from their company’s profits. They only pay tax on the dividends taken, so by leaving profits in the company, owners will save tax. Whereas sole traders and partnerships pay tax on the profits made, regardless of how much money they take out of the business.

Companies save you tax when your family owns it

If a company has one owner, only that owner can take dividends from the company. So all of the profits taken out of the company (as a dividend) are taxed on that one owner. Which could mean they pay higher rates of tax if their total income for the tax year exceeds about £50k. However, say a husband and wife own the company 50% each. Both the husband and wife will be able to receive dividends from the company. The total dividend is split into two – 50% each. So the dividends received per owner is halved. If that means both owners pay lower rates of tax on the dividends, rather than the one owner paying a higher rate of tax, the family saves tax overall.

Family ownership example

For example, a company has retained profits of over £100k and the directors decide to pay a dividend of £100k. So, if there’s only one shareholder (owner), and they have no other income in the tax year, they will pay no tax on £13k, lower rates of tax on £37k and higher rates of tax on the other £50k. This is a total tax of about £20k.  However, if there are two 50% owners, they will each receive £50k. Then if they have no other income, they will each pay no tax on £13k, and lower rates of tax on £36k. A total tax of about £6k. That’s a total saving of about £14k! You could take this further by making adult children shareholders too. You can also own the company in different proportions e.g. 75%/25%, so that the total dividend is split 75%/25%.

ABC Shares

If each owner’s other income is different and varies from year to year, the company could create different types of owners, so that it can pay different dividends to each owner. A company does this by having different types of shares. For example, instead of having 100 ordinary shares, a company could have 50 A shares and 50 B shares. If one owner owns all the A shares and the other owner owns all the B shares, they both still own the company 50% each. However, they can each receive totally different dividends.

So let’s say the company wants to pay a total dividend of £80k, and the B shareholder has other income of £20k. If the B shareholder was to receive a 50% dividend of £40k, their total income would be £60k. So they would be paying higher rates of tax on £10k of that dividend. However, the company can pay £50k to the A shareholder and £30k to the B shareholder. That way they both stay under the £50k higher rate threshold, so they both pay lower rates of tax.

Other ways of extracting profits

As a company is a separate legal entity to you, the director/shareholder, you can take profits out in other ways.

You could charge the company rent for using part of your home using what’s called a licence agreement. The rent received is taxable income, however, you can deduct proportion of your home costs from the rent. So there is no/little tax payable. This is the only way of claiming rent or mortgage interest as an expense.

If you loan money to the company you could also charge it interest on that loan. The interest is taxable but only if your interest is more than the tax-free savings allowances. The company also has to deduct income tax from the interest but that’s taken into account on your tax return.

How to save tax as a limited company

So hopefully you now know how to pay less tax as a limited company compared to a sole trader. To summarise you can either 1) have less than £87k profit, or 2) keep enough profit in the company, or 3) share the company with your family, or 4) take funds out in other ways. We don’t charge any fees for registering a new company for new or existing clients. New clients are asked to pay the first month of their accounts fee. Companies House charge a fee of £12 for a new company and then £13 per year.

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