How the right business structure can reduce your tax bill

by | Nov 26, 2021

Every business owner knows one of the first rules of starting up is to pick the most suitable business structure, not least to comply with tax obligations.

Generally speaking, there are three main types of business structure in the UK – sole traders, general partnerships, and limited companies.

There isn’t a lot of difference between the first two structures. They’re both self-employed and must pay income tax each year.

Limited companies and other incorporations are liable for corporation tax, although there is usually much more red tape involved.

It’s possible to start out as a self-employed business and upgrade to an incorporation, but it can prove particularly costly.

Of course, that’s a very broad overview of the three structures and there are pros and cons for each one.

So, let’s have a look at the most tax-efficient business structure and the best ways to reduce your tax bill.

Sole traders

More than half (56%) of the UK’s private-sector businesses are made of sole traders. That roughly equates to 3.2 million out of 5.6m firms.

As a sole trader, you run your own business as an individual and you’re self-employed.

All of your profit is taxable to you personally and you keep all the profits after tax, but you’re also liable for any losses the business makes.

You’ll pay income tax above the personal allowance at either 20%, 40% or 45%, and you’ll have to make National Insurance contributions (NICs), too.

Claiming allowable expenses is the best way to reduce a sole trader’s tax bill. Typically, these are various running costs that can be deducted before your taxable profit is calculated.

Another tax-efficient strategy for sole traders is to make pension contributions during the tax year, as they won’t count towards your taxable profit. You won’t pay any tax on these contributions until you start to receive retirement income from your pension.

Partnerships

Almost all of the above applies to general partnerships, which make up around 7% – or 384,000 – of the UK’s private-sector businesses.

Like sole traders, business partners are self-employed and liable for income tax and NICs. They even pay income tax the same way.

The key difference is that two or more people manage and operate the partnership. They share any profit and are equally responsible for any losses the partnership makes.

As business partners are usually self-employed, the aforementioned tax-efficient strategies apply to them just as they do to sole traders.

Limited companies

A stat that always surprises us is that roughly one in three – or 37%, according to the most recent business population report, of private-sector businesses are trading companies.

It surprises us because, in our humble opinion, operating as a limited company can be by far the most tax-efficient way to run a business. Not only do you have less responsibility as a director, you keep more of your company’s profits.

If you decide to set up a limited company, for example, you will become a director and shareholder of that incorporation. You’ll be responsible for making the legal and financial decisions, but the company’s assets and liabilities are separate from your own.

You pay yourself by extracting the company’s available profits, often through a combination of tax and NICs-free salary, dividends (which have lower tax rates than income tax), and pension contributions. Corporation tax applies on what remains of the company’s profit.

Not only does this offer reduced liability, but it offers the opportunity for greater profitability. At Atreus, we can extract profits from your company in the most tax-efficient ways and handle all of the additional paperwork involved with running your business. Call us on 01202 052276 or send us an email at info@atreusaccountants.co.uk to find out more.

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