Should you incorporate?
As a sole-trader you pay tax on all the profits made by your business, at rates that can vary from 20% to 45%. You also pay National Insurance Contributions (NIC) at 9%, or at 2% on higher profits. If you transfer your business into a company (an incorporation), the company will pay tax on all its profits at 20%, a rate which will drop to 19% in 2017.
That looks like a no-brainer – you would save tax by operating through a company. But it's not that simple: you need to pay further tax and NIC when you take money out of the company. The exact amount payable depends on how you take your money – as salary, dividends, a combination of the two, or perhaps with benefits such as a car or van.
The tax system is currently unintentionally biased towards extracting most of your money as dividends, which are tax free within your basic rate band, and taxed at only 25% in your higher rate band. However, the system is about to change from 6 April 2016, when income tax will be charged on dividends at 7.5%, 32.5% or 38.1% as we explain in more detail below. This will reduce the tax savings from operating through a company considerably, although there will be savings to be had at higher profit levels.
When weighing up the tax costs and savings you mustn't forget the extra administrative costs involved in running a company. These include filing accounts and annual returns at Companies House, and electronically filing the corporate tax return and accounts with HMRC. The company will also have to register for PAYE, and possibly VAT, which normally require monthly or quarterly online returns.
There are good reasons to incorporate, but also some disadvantages, so talk to us about all the implications first.