Is It More Tax Efficient To Be A Limited Company? | Checkatrade
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Is it more tax efficient to change from sole trader to limited company?

The tax system is pretty complicated and nobody wants to pay more tax than they need to. That's why you're looking to see if being a sole trader or changing to a limited company is more tax efficient. Keep reading to find out.
which is more tax efficient - sole trader or limited company?

Which is more tax-efficient: being a sole trader or a limited company?

The legal structure of your business will have an impact on how you are taxed.

So the big question is whether it’s more tax-efficient to be a limited company or a sole trader.

Do you pay less tax as a limited company?

It’s more tax-efficient to be a limited company as opposed to a sole trader.

  • A limited company pays corporation tax rather than income tax, and income tax is generally charged at a higher rate.
  • A limited company can also reduce the amount of tax it pays due to the tax allowances and tax-deductible costs it can claim against.

What’s the most tax-efficient way to take money out of a company?

The most tax-efficient way to take a salary from a limited company is to draw a low salary from the company and take the rest in dividends.

Dividends are a way for a limited company to distribute its profits to its shareholders. Dividends are taxed, but there are ways to minimise the amount of tax you pay:

  • Use your tax-free dividend allowance.
  • Use your personal tax-free allowance.
  • Keep your shares or funds in a stocks and shares ISA.

Our article, What tax do I pay on dividends, helps to crunch the numbers.

Sole trader vs limited company tax calculator

If you’re unsure of the differences between sole trade and limited company, check out this blog of ours – it explains it all!

The tax difference between being self-employed and a limited company can seem like a minefield. Let’s keep it simple:

  • Sole trader. If you’re self-employed and your business operates as a sole trader, you’ll pay between 20-45% income tax on all taxable earnings. You will also pay Class 2 and Class 4 National Insurance.
  • A limited company pays corporation tax on its profits at 19% (this will increase to 25% for the financial year beginning 1st April 2023). You can then minimise your income tax and National Insurance liabilities by paying yourself a low salary and the rest as dividends.

National Insurance contributions are not payable on dividends, but a limited company and its employees do pay Class 1 National Insurance on salaries.

sole trader notepad

When should you change from sole trader to a limited company?

Most people when they start their business start as sole traders, but as the business grows, so does the level of personal responsibility for losses and tax. It’s usually at this point tradespeople change from sole trader to limited company.

Incorporation

As a sole trader, you and your business are one and the same from a legal point of view.

When you change from a sole trader to a limited company (becoming incorporated), you become a separate legal entity to your business.

  • Greater tax efficiency is often a key consideration for those changing from a sole trader to a limited company.
  • However, incorporation gives the company owners limited liability protection. This means that if the company is sued, for example, your personal assets are kept separate. It gives you greater protection as an individual.
  • Financial investment is another reason for people switching from a sole trader to a limited company. Becoming a limited company allows you to seek investment by selling shares in the company.
  • Being able to secure your company name is also an attractive reason to switch. When you become a limited company only you can use that business name. This is particularly useful if you have aspirations for growing and developing the brand.
  • Added prestige. The wording ‘Ltd’ adds to your professional image, helping to build both confidence and trust in your brand.

If you’re considering changing your business from a sole trader to a limited company you should discuss this carefully with your accountant first.

Limited company notepad

The disadvantages of changing from a sole trader to a private limited company

From a tax perspective, forming a limited company is a really tempting move. But there are some disadvantages.

Changing from a sole trader to a limited company means:

  • Less privacy. You will need to share company information publically via Companies House. This includes details of the directors’ and company earnings.
  • Legal responsibilities. Directors of a limited company have significant legal responsibilities.
  • Higher admin costs. These additional responsibilities mean more filing and reporting, which typically leads to higher administration costs.
  • Higher fees. A limited company can have more complex accounting and taxation requirements, which means higher accountancy fees.

You will need help keeping on top of your finances if you switch to a limited company

Becoming a Checkatrade member can help you in more ways than one.

It’s no secret that becoming a Checkatrade member gets you more leads, but there are other benefits too.

Within our collection of exclusive member benefits, we have a partnership with Powered Now, the creators of the invoicing app 1TradeApp – created for by the trade for the trade.

Becoming a Checkatrade member means you can download this invoicing app for free!

it’s a no brainer – whether you stick it out as a sole trader or go limited, we can help you to continue growing, but also staying organised.

Need help managing finances?

All our members get a free invoicing app. You can too!

Join Checkatrade today

Quick summary

While a sole trader is the simplest business structure (and the most popular), a limited company is more tax-efficient.

  • This is mainly due to a limited company paying corporation tax rather than the (currently) higher rates of income tax.
  • As well as this, limited companies can take advantage of certain tax allowances and tax-deductible costs.

However, tax efficiency is just one of the things you should weigh up before becoming a limited company.

Every business has its own set of unique circumstances. We, therefore, recommend you speak with your accountant to understand the pros and cons of a sole trader and limited company to help make the right decision for your business.

FAQs

Is a Ltd company more tax-efficient than a sole trader?

It is considered to be more tax-efficient to be a limited company than a sole trader. This is due to a limited company paying corporation tax as opposed to the higher rate of income tax. There are also various tax allowances and tax-deductible expenses a limited company can claim against.

What is the most tax-efficient way to take money out of a company?

The most tax-efficient way to take money out of a limited company is to take a low salary and top this up with dividends.

Can you swap from sole trader to limited company?

Swapping from a sole trader to a limited company (becoming incorporated) is indeed possible. Doing so will change the legal structure of the business and the amount of tax you need to pay.

Need help managing finances?

All our members get a free invoicing app. You can too!

Join Checkatrade today

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