As all contractors will now be aware, from April 2016, dividends will be taxed differently, and the limited company “owner director” will highly likely pay more tax than they do currently. The question many contractors and freelancers are asking is, “does it still pay to be limited, taking everything into account?”.
How much extra in tax will I pay?
A typical set up for a contractor who is a director and shareholder of their own limited company is to take the minimum salary of circa £11,000 per year, then takes the rest of their earnings in dividends.
Some smaller contractors, or those with modest personal living costs will only take up to the top of the basic rate band. For this group of contractors, the additional tax, very broadly speaking, is £2,000, although it does vary if there are additional income streams.
Other directors who draw dividends over the basic-rate tax threshold, will end up paying an additional 7.5% on their existing tax bill, again, very broadly speaking.
Is limited company still the tax efficient for my business?
Historically, being a limited company has always been the most tax efficient trading vehicle for contractors and freelancers, as dividends are free from National Insurance contributions, and the rate of tax has always been more advantageous than that of a sole trader.
Only those with dividends under £5,000 per year will really gain from this new tax structure. Everyone else will be digging their hand in their pocket to cover the extra liability.
So, is trading as a limited company still the best option?
Figures show that, in almost all cases for contractors and freelancers, it will still be beneficial from a tax perspective to trade as a limited company.
When profits reach around £140,000 then the tax liability is more or less equal to that of a sole trader, so essentially this would be around the time where a decision would need to be made as to how best to proceed.
Other factors come into the decision too.
Bear in mind it isn’t just tax that makes the decision of “limited company versus sole trader”, although this is clearly the main factor.
The “limited liability” element is attractive to both contractors, and, who they contract for, sometimes helping them secure better or longer contracts. On the flip side, management costs of a limited company are more than that of managing self assessment, so this also needs to be taken into account when weighing everything up.