Getting started as a locum – limited company v self-employment (part 1)

In my last article we discussed creating financial security no matter what life throws at you. This month – should you set up as self-employed or a limited company? 

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 term time for the children. Annually she makes £114,000. Her husband Jeremy is a data analyst making £45,000 a year full time. Maria’s priority is to build a little nest egg for the children so they can graduate university close to debt free, as well as maintain healthy NHS pension contributions.

Now this scenario is multifactorial and not easy to solve. For this article, we will start with a limited company and contrast next month with a sole trader structure. Maria needs to bear certain things in mind. The nest egg for the children in a limited company cannot simply just be paid to the children or their university if they do not work for the company. This applies to anything you might want to use the limited company structure, for example house deposit, car purchase, 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 in kind at her top nominal tax rate, which on current income would currently be 40%. But Maria has a number of options to make this more efficient:

1)    Make Jeremy a shareholder. Everyone has a dividend allowance annually, which is tax free currently up to £2,000. Both she and Jeremy can take £4,000 a year, which would serve as a plan to start the children’s nest egg before they reach 18 years old. However, they are paid from post-tax profits, so they don’t attract corporation tax relief like a salary would.

2)    Make the children shareholders. While the children are under 18, any dividends will be counted as the gifting parent’s and so taxed at Maria’s applicable rate of dividend tax. After they turn 18, this does not apply. You do not pay tax on any dividend income that falls within your personal allowance. This is the amount any individual can earn from sources such as salary, dividends, investments or pension without paying income tax – currently £12,570. With this in mind, if the children do not work during university, she could provide each with a personal allowance made up of a dividend up to £12,570 plus a £2,000 dividend allowance every year completely tax free for them to support themselves. She has to bear in mind that 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% – much less than her 40% income tax rate if she had taken it out as own salary.

3)    Employ Jeremy. For HMRC to be happy with this, Jeremy needs to be making a contribution and his pay would need to not be above market rates. Jeremy is responsible for booking Maria’s work, taking enquiries, chasing late payments and keeping her expenses spreadsheet up to date. For this she pays him £14 an hour and he keeps a log of the hours done each month, usually eight hours. This £1,344 a year will be taxed at his nominal tax rate 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 this second job role. This method means 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? Earning between £12,570 (personal allowance) to £50,270, Maria will have income tax of 20%. Between £50,271 to £150,000 income tax is 40%. Maria could decide the combined household income is sufficient if she takes a pay cut. Anything she earns as self-employed is eligible for NHS pension, 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.

As you can see, limited company structures can be beneficial if you know what you are doing, so get proper financial advice. There are a number of 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.