One-man companies – tax efficient moving forward?

One-man companies have long been at the heart of the UK’s business community, a group of savvy entrepreneurs and resourceful businesspeople who are often at the forefront of innovation and change. Many who operate their business in this way choose to run a Limited Company and pay themselves a combination of salary and dividends in order to access their profits and “pay themselves tax efficiently.”

If you operate your business as a ‘one-man’ Limited Company, things are about to change dramatically for you. On April 6, 2016 the UK will enact new taxation laws and regulations on dividends, and as a result, tens of thousands of UK businesspeople could stand to lose out. The changes proposed will see the tax rate on dividends increase by 7.5%. For many one-man businesses, this tax hike could be the difference between fiscal solvency and finishing the year in the red. Will these changes affect you?

Current wisdom around dividends and one-man companies

Until now, most company owners ascribed to the general rule that if a business makes annual profits of £25,000 or more, it would be more tax efficient to run your business as a Limited Company as opposed to a sole trader (or partnership). The profits are then extracted as a reasonable salary, with the rest processed as dividends.

Now that the new taxation rules have been announced, the threshold at which it makes sense to incorporate will undoubtedly change for most companies.

The advantages and disadvantages of dividends moving forward

For anyone using the above profit extraction strategy, things are about to change. For example, a business that has annual profits of £30,000 and is run as a Limited Company will save approximately £700 on their yearly taxes than one that is unincorporated. If the profits were to increase to £60,000, the tax benefits will increase to approximately £3,500, making this the obvious choice for businesses of this size.

However, by the time a business begins to turn larger profits, this benefits dwindle, and are completely lost when the profits reach £130,000. Once your profits soar beyond this point, you will be paying more tax when using a Limited Company. At this point, it may be more tax efficient to disincorporate.

Is disincorporation your best option?

Once you reach £130,000 in annual profits, it seems obvious that you should stop running your profits through a Limited Company – but things are not always so cut and dry and you have to consider how much of that profit you are extracting. You can actually come out ahead by leaving some of your profits in your company, and these profits will not be taxed at the new higher dividend rates. If you elect to enact this strategy, you can take these profits at a time when you will be taxed at a lower rate, for instance when you retire.

Is £130,000 always the magic number?

In a simple word: no. Just because you have had a fantastic year and surpassed this £130,000 mark does not mean that you will do the same next year – disincorporating in order to save taxes will be a premature move in the event that you fall below this rate in the future. Before making any dramatic changes, you must ensure that your success is here to stay.

And finally…

As with any tax advice, it is important to consider all possible implications and the protection of limited liability that a Limited Company often offers will far outweigh any potential tax saving; therefore any changes in the structure of your business need to be fully considered.

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