Are limited companies tax efficient?

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It’s widely said that contractors operating through a limited company are the most tax efficient – but is this actually true?

Never fear, we’ve put together this handy guide to test that theory and find out whether things really are as good as they seem.

What are the financial perks of running a limited company?

As a company director and shareholder, you can take your earnings from the business as a combination of salary and dividends – limiting the amount of tax you’ll personally have to pay.

The difference is made up by your company, which pays 20% in Corporation Tax to HMRC, reducing to 19% from 1st April 2017 and 18% from 1st April 2020.

Sole traders don’t have this option, so they’ll have to pay Income Tax on all their trading profits. This could be pretty costly if they earn more than the high rate threshold of £32,000 – and as much as 45% if they’re an additional rate taxpayer.

What is the most tax efficient way to pay myself as a limited company?

We understand that you’ll want to make the most of your tax-efficiency – and why not? If you pay yourself a salary up to the National Insurance Contributions threshold (£8,060 for the current tax year), you’ll be able to avoid Income Tax completely.

You can then take further dividends up to £7,940 net without having to pay tax. Any amount over this threshold will still attract a lower rate than Income Tax – meaning you’re saving money again!

For more information on dividends, please see our guide.

Are there any other benefits of running a limited company?

Yes, lots! Because the structure of a limited company is extremely flexible, you can leave surplus income in your business to be withdrawn in the future – particularly useful if removing it now would result in a higher tax rate.

You can also borrow an interest-free loan of up to £10,000, making it a great alternative to traditional lending. Don’t forget, you’ll need to pay this back within nine months of the company year-end or it will attract additional tax charges.

If you decide to close your company, you could also incur additional tax benefits. This is because any funds left in the business once it has been wound up are deemed to be capital gains and are subject to Capital Gains Tax rather than Income Tax.

The first £11,100 of any capital gain received is tax-free, while anything over this amount could be subject to as little as 10% tax. This is a great way of reducing your tax liability and is particularly effective if you are due to take a highly-paid permanent position within the same tax year that would attract a high level of Income Tax.

Please note that you won’t get this tax relief if you close your company and open a new business that’s involved in the same trade or activity within a 24 month period. If you think you might be affected by this, please see your accountant for further guidance.

A final tax-efficiency measure comes into play if your spouse or civil partner plays an active role in your company. In some circumstances, it may be beneficial to add them as an employee and/or shareholder. For more information on this, it’s a good idea to speak to an accountant.

What can ClearSky Contractor Accounting do for me?

We hope that this guide has helped shed some light on how a limited company can be tax-efficient. If you’d like a bit more advice, look no further!

At ClearSky Contractor Accounting, we’re committed to helping you make the most of your finances. Our dedicated team of experts is on hand to answer any queries you may have. Where it’s assistance with setting up your company or IR35 guidance you’re after, we’ll be with you all the way.

To get in touch, please call 08000 861 406 or email enquiry@clearskyaccounting.co.uk.

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