In my last article, we discussed creating financial security. This month, we’ll take a look at whether you should set up as a limited company or self-employed.
This is completely dependent on your goals and circumstances, and you could do both. Let’s work through a typical example. Maria is a 35-year-old with two children (six and eight years old). She earns £750 a day doing four days a week. She works 38 weeks a year during term time for the children. Annually, she makes £114,000. Her husband Jeremy is a full-time data analyst earning £45,000 a year. Maria’s priorities are to maintain healthy NHS pension contributions and build a nest egg for the children so they can graduate from university close to debt-free.
This scenario is multifactorial and not easy to solve, so we’ll start with the limited company structure and contrast it next month with that of the sole trader. First, Maria needs to bear certain things in mind. The nest egg for the children in a limited company cannot just be paid to them or their university if they do not work for the company. And this applies to anything for which you might want to use the structure, such as a house deposit, car purchase or wedding savings. Anything the company bills is not your money to withdraw without following HMRC rules, and anything purchased is usually owned by the company, not you.
In Maria’s case, if the company were to pay the university fees directly, it would be taxed as a benefit at her top nominal tax rate, which, on her current income, would be 40%. Maria has several options to make this more efficient:
1) Make Jeremy a shareholder: Everyone has an annual tax-free dividend allowance of £2,000. Both Maria and Jeremy can take £4,000 a year, which could start the children’s nest egg before they reach 18 years old. However, dividends are paid from post-tax profits, so they don’t attract corporation tax relief like a salary.
2) Make the children shareholders: While the children are under 18, any dividends will be counted as the gifting parent’s and taxed at Maria’s applicable rate of dividend tax. You do not pay tax on dividend income that falls within your personal allowance; this is the amount that anyone can earn from sources such as salaries, dividends, investments or pensions without paying income tax, which is currently £12,570. If the children do not work during university, Maria could provide each of them with a personal allowance made up of a dividend up to £12,570 and a £2,000 dividend allowance every year completely tax-free. Whatever she saved as the nest egg will have had corporation tax deducted in the year it was earned, as it is company profits. This is currently 19%, which is much less than her 40% income tax rate if she had taken it out as her own salary.
3) Employ Jeremy: For HMRC to be happy, Jeremy needs to contribute, and his pay would need to be below market rates. He is responsible for booking Maria’s work, taking enquiries, chasing late payments and keeping her expenses spreadsheet up to date. She pays him £14 an hour and he keeps a log of his hours each month (usually eight). This £1,344 a year will be taxed at his nominal tax rate of 20%, as he earns a total of £46,344 from this and his analyst work. With this level of monthly income, there will be no national insurance to pay in the second job role. This method means that the higher earning spouse can reduce the family tax burden.
4) Take a pay cut: If Maria is most interested in saving this nest egg as quickly as possible, she could bill some of her work as self-employed and the rest as limited company. Why would she do this? Well, earning between £12,570 (personal allowance) and £50,270, Maria will have an income tax of 20%. Between £50,271 and £150,000, income tax is 40%. Maria could decide the combined household income is sufficient if she takes a pay cut. Anything that she earns as self-employed is eligible for NHS pension, which is one of her goals. She cannot do this if all her income is through limited company. Each year, she earns £114,000, which is £63,730 above the 20% tax threshold. To save NI and tax, she could bill this excess through a limited company where it will only be taxed once at 19% corporation tax. She could set up the limited company for this purpose and register the company as dormant with HMRC once it has reached its savings goals, so annual fees explained below are not required. In future articles, we will discuss how she could be caught by IR35 on this.
Limited companies come with certain responsibilities and a few initial and ongoing costs, which are tax deductible.
|Incorporation with Companies House (easy to do yourself)
||£12 (once only)
|Payroll software to employ Jeremy and herself if drawing a salary
||£50 - £100/year
|Annual Companies House confirmation statement fee
||£0 - £120/year
|Accountant for limited company +/- self-assessment accounts (not obligatory if your software is good and you are comfortable to do it yourself)
||£800 - £1200
||19% on all profits (eg, after salaries and certain expenses are deducted but dividends are not included)
As you can see, limited company structures can be beneficial if you know what you are doing, so get proper financial advice. There are several HMRC regulations to do with tax avoidance and, if done incorrectly, the solutions above can be seen as tax avoidance. In my next article, I will discuss more about the self-employed structure for trading and IR35.
The Lockdown Locum is a locum GP in England, who wishes to write under a pseudonym.