One subject that many contractors debate over is whether they would be better moving from being self-employment to limited company status or whether they should stay as they are. While every contractor’s situation is unique and there is no across the board right, or wrong answer to this dilemma, on this page of The Smart Contractor, we’ll give you the information you need to decide whether or not you should go to the next step and at least seek a professional point of view.
Your current situation
Two of the biggest things that will indicate the right time to make the move from self-employment to limited company status are your performance and your plans for the future. And here are just some of the things you should be thinking about in particular:
Your income: How much are you expecting to earn in the year ahead? Generally speaking, the watershed income level to justify the move from self-employment to limited company status is £25,000. If you are expecting to earn £25,000 or more in the coming year, then the likelihood is that operating through a limited company would be more beneficial for you. However, this isn’t always the case and you should speak to us before making the final decision.
Your expenses: Every business has expenses, but one of the attractions of trading as a limited company is that you can claim a wider range of expenses than you can on a self-employed basis. If this sounds like a situation that would apply to your business, then it is likely to be worth exploring limited company status in more detail.
Your plans: Are you in business for the long-run? If you are planning a long-term future as a contractor, then limited company status will definitely provide you with a more comprehensive range of tax planning opportunities than self-employment.
Risk: All businesses come with an inherent risk and when you are self-employed, it is you personally who is liable for any debts that your company runs up. What this means is that your personal assets, such as your house could be at risk because of activities within your business. When you run your business as a limited company, your personal assets are ring-fenced and as such are not exposed to this risk because they are separated from the finances of the company.
When you are a self-employed contractor, from a tax point of view, your personal affairs and your business are dealt with as one. Once you set up a limited company, you will have to complete a tax return for yourself and for the limited company. Although having all your tax affairs dealt with in one place may seem like the lesser of two evils, it can be an inefficient way of running your affairs.
The tax advantages of moving from self-employment to limited company status
As an individual, you benefit from the personal allowance and then move on to pay tax at the basic rate up to the threshold for that and then on to the higher or additional rate of tax. When you run your contractor business under a limited company set-up, your personal and business affairs are separate and as a limited company, you pay Corporation Tax.
The rate of Corporation tax set for 1st April 2017 is 19% and 1st April 2020 18%. So as you can see, for anyone whose income is likely to take them into the higher or additional rate of tax, a limited company is an extremely attractive option. Even the 1% difference at a basic level is worth paying attention to.
When you set up your contracting business as a limited company, you effectively become an employee of your own company. You set your own salary and can plan that according to your needs and your personal tax situation. Income can be split between salary, on which you will pay PAYE and National Insurance Contributions, and dividends. The attraction of dividends is that they do not attract National Insurance Contributions.
So as you can see, the tax planning opportunities when it comes to contracting within a limited company are significantly greater than they are when you are operating on a self-employed basis.
VAT and National Insurance
For the tax year 2017/2018, any self-employed contractor or limited company must register for VAT when their turnover reaches £83,000. Many contractors are fearful of the VAT system, but it’s actually much simpler than many people imagine – in many ways it’s just a case of being more organised. In effect, once you are registered for VAT, you need to charge VAT on your services and repay the VAT you charge to HMRC. Normally this is done on a quarterly basis. And one of the big advantages is that in most cases, contractors can register for the flat rate VAT scheme, which means that they charge VAT at 20% but repay the VAT at a lower rate, creating an opportunity to increase their income.
When it comes to National Insurance, as a self-employed contractor, you pay Class 2 and Class 4 National Insurance Contributions (NICs) on your income. As an employee of your own limited company on the other hand, the company and you would pay Class 1 NICs for any salary and no NICs on dividends.
You can find a comprehensive guide to tax and NIC rates here.
Many self-employed contractors spend valuable time sitting on the fence when it comes to deciding whether or not to set up a limited company. Fearful that it will create an administrative burden or an accounting nightmare, they forego the tax planning opportunities that this structure could offer them.
While limited company status isn’t right for every contractor, if you have read this page and suspect you might benefit from changing, why not get in touch? We have teams of experts on hand who can help you make the right decision for you, your business and your future.