Following my previous post, I’ve had a couple of emails from people thinking of switching from self-employment to limited company status, so I thought I’d whizz over the info I harvested when making the decision, in case it proved useful, for translators specifically. Needless to say, I’m not a qualified accountant or lawyer, so don’t rely on what I say as the be all and end all. Everybody’s circumstances are different. I think my situation is probably fairly simple – I have income only from translation, I work from home (no travel\/car for business, which does add complexity), my tax code is ‘normal’, and so on.<\/p>\n
Given that “tax efficiency” is often a motivating factor behind the decision to change status, most of this post will deal with the financial comparison. This post originally had almost no figures – on reflection I actually believe it’s clearer to include them, so I now have. The thresholds and percentages are all for the just-ended 2011-2012 financial year.<\/p>\n
Self-employment<\/span><\/strong> The result is your “profit from self employment”, on which you then pay the following to HMRC:<\/p>\n a) personal income tax on earnings over your personal allowance (\u00a37,475 being the standard allowance), at the basic rate of\u00a0 20% on the first \u00a335,000 and 40% over that, up to \u00a3100,000 (it does get complicated after that, with reductions in personal allowances and more tax bands, but I think we can disregard that for the purposes of this exercise, since unless you are proving a political point in a Boris or Ken way, if you’re on 100k and haven’t got a limited company already…). The observant will note that the figure where Class 4 NI contributions drop to 2% is the same as the upper threshold for basic rate income tax + the ‘standard’ personal allowance. So a quick and dirty tax+NI combined calculation could be that from your profit from self-employment, the first 7,400 or so is tax free, you pay 29% on the next 35k, and 42% after that.<\/p>\n Moving away from quick and dirty into the wholesome sphere of accurate number crunching for running a comparison, do not overlook the fixed rate class 2 NI which is another deduction from your earnings, but not a tax-deductible one. And was only \u00a3130 in 2011-12, but still…<\/p>\n Limited Company<\/strong><\/span> Given that, the company’s gross income is your invoices, like before. a) the salary paid to the director(s), likely to be = \u00a37,475 (so the director’s personal income tax = nil) That gives you a taxable profit for the company from which you then deduct company tax at 20% (small company rate). So, in terms of income for the shareholder\/directors, if dividend payments are not high enough to push the individual receiving them into the higher personal income tax bracket (a simplification – there is a tax credit of 10%, and it is the notional grossed up figure on which this calculation is based, not the actual amount of dividend paid itself, which is taken actually be = 90% of the notional 100% figure), then you don’t pay personal income tax on them.<\/p>\n Summary<\/span><\/strong><\/p>\n Certainly as things stood for y\/e April 2012, then disregarding the minor differences in the thresholds and assuming no higher rate tax, as both company tax and basic rate income tax were at 20%, the saving made from operating as a limited company was very broadly equal to the 9% paid in Class 4 NI. Hence, even at relatively low income levels, assuming 9% of your earnings over \u00a37,475\u00a0 is not greater than any potential extra costs incurred (e.g. accountants, or lost allowances permitted under s\/e), and assuming you are in a position to opt for reasonably tax optimised arrangements in terms of salary levels and shareholdings, it can still make real sense to change status.<\/p>\n You can find websites that will do these calculations for you, but one drawback I found was that they do assume the start point “net profit” figure is the same if you’re self-employed as it is as a limited company. Which it may not be, and in my case certainly is not – see comments about allowances earlier.<\/p>\n The other point to note is that the cash flow is almost certainly going to be different. As a self-employed person, I was used to just transferring money from the business account to my personal account as and when the fancy struck. While in theory a company can pay dividends as often as it likes, a) the directors have to pass a resolution and issue formal document vouchers, and b) ideally, there has to be a P&L drawn up showing that the company has sufficient cash reserves to pay a dividend. You can<\/em> bypass this with directors loans accounts and suchlike, topped up by dividend payments subsequently, but in terms of keeping your head down and your nose clean, it doesn’t seem (judging from comments in accounting forums) that using such a facility regularly is a good idea.<\/p>\n Any questions? \ud83d\ude42<\/p>\n","protected":false},"excerpt":{"rendered":" Following my previous post, I’ve had a couple of emails from people thinking of switching from self-employment to limited company status, so I thought I’d whizz over the info I harvested when making the decision, in case it proved useful, … Continue reading
\nAs I’m sure any s\/e people will know, the financial maths itself for basic self-employment is fairly straightforward.
\nThe invoices sent out are your gross income (accrual basis these days, not cash).
\nFrom that you can deduct business expenses and allowances (more on allowances later).<\/p>\n
\nb) Class 4 National Insurance on profit from self-employment (the same figure as above, so yes, this is effectively a second tax on the same money) at a rate of 9% on that profit between \u00a37,225 and \u00a342,475, and 2% on profit over that level (ad infinitum, AFAIK).<\/p>\n
\nLimited companies are a tad more complicated, because there are more variables, the main ones being how many directors and shareholders there are, and whether those directors draw a salary, and if so how much. However, the guidance for tax efficiency, disregarding other considerations, is that a director should draw a salary at a level whereby they pay a small amount of NI (for state pension entitlement purposes) but not enough to pay personal income tax.<\/p>\n
\nFrom the gross figure , you can deduct the business expenses, as before. However, you cannot deduct allowances for use of the home as an office to the same extent (I know some s\/e don’t use this allowance fully or at all anyway, for fear of CGT liability later), so if doing a hypothetical comparison calculation, you need to add these allowances, if any, back in for the calculation. Furthermore, if you’re not<\/em> already using an accountant as a self-emp’d person (I wasn’t), you will need to deduct a further business expense in accountant’s fees, which I think are inevitable in the first years of a limited company at least.
\nYou will also need to deduct as a company expense, which you would not do under s\/e status:<\/p>\n
\nb) and the (small) amount of employers’ Class 1 NI contributions being 13.8% on salary(ies) over \u00a37,228.<\/p>\n
\nAfter company tax has been deducted, you can pay up to the amount left (retained earnings) in dividends to the shareholder(s).<\/p>\n
\nIn summary: If self-employed, you’d take your profit from self-employment, and pay 20% income tax and 9% NI on the amount above \u00a37,400-odd, as mentioned earlier.
\nIf a company, you’d pay yourself a salary equal to your personal income tax allowance (\u00a37,475), the company would pay 20% tax on its profits (after your salary is deducted as a cost to the company) and then pay dividends, essentially tax free, to you, up to \u00a331,500 (=35k grossed up).
\nThe 20% tax paid would be broadly the same, although paid by different entities; the difference is the 9% NI deducted for the self-employed.<\/p>\n