When people decide to take the plunge and start working for themselves, there are always a lot of questions for the accountant! If it’s the first time working for yourself, there’s usually an element of uncertainty about how to make it all work financially; how do you get paid? How do you keep the taxman happy? How do you go about expenses and costs?
This is usually when the conversation about setting up a limited company arises, but it can leave people a little confused – what is a limited company and why would you need to be one?
Many people still think of being Self-Employed as it was in the old days, such as your gardener, window-cleaner or even driving instructor – one person does the work and filled out a tax return at the end of the year. This is known as Sole Trader and is exactly as it sounds, one person working independently.
There are a number of potential drawbacks to being a sole trader and one of the biggest is liability. If your business suddenly drops off, then as only you are the business, any debts are your personal responsibility. Imagine a driving instructor; if lessons suddenly dry up and the car payments stop, then any assets – including your house – could be used to recover payment. If you face litigation or somebody sues, then the same applies and you’re personally liable.
Setting up a Limited Company overcomes these issues – your liability is limited to being a shareholder. Essentially, you create the company and become the company director as well as an employee. If the company is sued, you don’t risk company debts being recovered from you personally – the only time this would apply would be for illegal or fraudulent activity.
Limited companies also make getting paid and paying tax easier. By allowing your accountant to take care of payroll, you are paid PAYE – Pay As You Earn. Instead of tracking how much money you take in and pay out over the year, you give yourself a monthly salary, just as you would if you worked for somebody else. If you earn enough to pay tax, then you can pay it direct to HMRC instead of waiting for the end of the year. The same works for National Insurance.
The benefit of being a limited company that interests most people, however, is the ability to take Director’s Dividends. If your company does well, then as a director and shareholder you get to take some or all of the previous year’s profits – and best of all, some of it is tax-free! For this year, the good ol’ tax man will let you have the first £5,000 without taking any tax! If your business does really well, then the good news is that anything over £5,000 has a tax rate of 7.5% (up to the higher rate taxpayer threshold), which is a lot lower than the normal Income Tax rate of 20%. It’s worth bearing in mind that dividends can only be paid on company profits, which have already had the Corporation Tax paid on them.
Being a limited company allows you to concentrate on your day-to-day work, rather than a constant niggle in the back of your mind about the taxman or keeping track of how much money you’ve taken so far this year. Although it might feel like a big step to set up an entire company, there are many benefits, from protecting yourself legally right through to being able to earn more money!