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One of the main tax disadvantages of a sole trader/partnership is that the proprietors are taxed on the total of their business profits irrespective of how much is actually withdrawn from the business. Having to pay income tax and national insurance on relatively healthy profits can put an enormous strain on cash flow where that business is attempting to expand.
The following example provides an indication of the annual tax savings (to the nearest £100) which are currently achievable for 2014/15 at various profit levels by a sole trader incorporating a business:
Profits |
Total Tax and National Insurance |
Potential annual saving | |
|
SOLE TRADER |
COMPANY* |
|
£25,000 |
£4,700 |
£3,400 |
£1,300 |
£50,000 |
£13,000 |
£9,200 |
£3,800 |
£100,000 |
£34,000 |
£29,200 |
£4,800 |
£150,000 |
£59,000 |
£53,000 |
£6,000 |
*Assuming sole director/shareholder is paid a salary of £7,956 pa and that all of the remaining post-tax profits are extracted as dividends.
Whereas a salary figure above £7,956 gives rise to Employee Class 1 NIC it should be noted that from April 2014 the first £2,000 per company of EMPLOYER Class 1 NIC liability is exempt.
So for example, with company pre-tax profits of £25,000, increasing the 2014-15 salary of a sole director from £7,956 to £10,000 (equal to the tax-free personal allowance) would result in a modest reduction in overall tax and NIC payable of £164. At the £50,000 profit level with a £10,000 salary the overall tax saving reduces to £112. The net savings take into account the additional corporation tax relief on the higher salary.
However in order to use the Employment Allowance in the most effective way, salary levels must be tailored to each situation by taking into account other factors such as ~ any investment and rental income of a director, the income position of co-directors and the number of and salary levels of other company employees.
The Employment Allowance can also be used against any Employer Class 1 NIC liability of staff employed by a sole trader or partnership but note that it is NOT available to set against any Class 4 or Class 2 NIC levied on self-employed profits.
Full details of the Employment Allowance can be found at the following link:
http://www.marshvision.com/NIC-Employment-Allowance.asp
Even further tax savings are of course possible where some of the post-tax profits are retained within the company or where a husband and wife are both directors and shareholders. For example, where £100,000 annual profits are currently shared equally within a husband and wife partnership, the overall tax saving potentially increases to around £7,600 per annum by using a limited company structure.
The potential for director/shareholders to have flexibility over the amount and timing of salaries and dividends extracted from their company can also be very tax efficient in terms of: