A Question about Limited Company Dividend Payments

letsgoagain

Hi all, I have a question about how to pay myself in dividends as a limited company. I'm a little confused about how this is more tax efficient than just taking my income as a sole trader, hoping anyone can help clear that up for me.

Background and my (presumably flawed) understanding of the setup with questions in bold:

I've been self-employed (sole trader) for a few years and am finally looking into setting up a limited company to save on tax/NI. I would be the director and sole employee. As a sole trader, my taxable income (post all expenses) is typically around £25k-£30k on a turnover of about £40k-£50k.

I would plan on taking a salary at the secondary NI threshold so that neither the company nor I as an individual pay NI. That would mean an income of £9k or so which I would need to top this up with dividends from the company's post-tax profits.

I understand I could take another £3k or so in dividends to take me up to the personal allowance. So now I'm at £12k and haven't paid any personal income tax (same as being a sole trader). However, the company (aka me) has paid 19% tax on that £3k that is now coming my way as dividends - isn't this worse than being a sole trader?

Then I can take another £2k as the tax-free dividend allowance. I haven't paid any personal tax on this extra £2k either (as a sole trader, I'd have paid 20%), but the company (aka me) has paid 19%. This doesn't seem like a huge improvement - am I missing something?

With a total income of £14k, I'm at least £11k short of my current income so I'd obviously need to pay myself more in dividends. 

Since dividends are paid out of the company post-tax, that company income has already been taxed at 19%. Now I'm taking a dividend income and will be due 9% personal tax on top of that. Wouldn't I now be paying 28% tax on income that would be previously taxed at only 20%?

Like I said, I'm sure I'm missing something obvious here, but I can't make it add up. I understand I will save on NI but this dividend confusion makes it hard for me to understand if it's worth the bother!

TIA

Dazed_and_C0nfused

Then I can take another £2k as the tax-free dividend allowance. 

There is no "tax-free dividend allowance"

There is dividend nil tax rate where £2,000 of dividends are taxable but get taxed at 0% (once all your Personal Allowances is used as in your example).

The £2,000 is still part of your taxable income and will use some of your basic rate tax band.

It's also included in your adjusted net income.  Which is what determines any High Income Child Benefit Charge payable and the Personal Allowance (where ANI exceeds £100k).

The dividend basic rate is only 8.75%, not 9%.

I think your biggest problem is differentiating between you (the individual) and the company.  

Do you have friends or relatives who could recommend a local accountant as it's probably worthwhile getting some professional advice.

letsgoagain

Thanks for the quick reply. I was perhaps a little lax with my terminology and rounding of figures, but you get the idea.

And I do understand the separation of the company from me. I just mean that for all intents and purposes, it's still tax coming out of my pocket when I compare it to life as a sole trader. I'm trying to understand the benefit, so it only makes sense to think of overall tax paid on the money I'm earning, regardless of whether it's the company or me officially paying it.

Jeremy535897

Class 4 NIC means that the rate of tax above the personal allowance (from July 2022) for sole traders is 29%, not 20%.

letsgoagain

Jeremy535897 said:

Class 4 NIC means that the rate of tax above the personal allowance (from July 2022) for sole traders is 29%, not 20%.

Thanks, yes I was deliberately keeping NI separate since I understand that part OK - I just wanted to see if I had the income/dividend tax implications of dividends straight.

So even with 9% NI, then the total tax is 29% (+ £3pw for class 2). Compare that to taking dividends where it's 19% tax for the company and then an additional 8.75% for the individual, you're paying 19% + (1-19%)*8.75% = 26.09% total on those payments (and yes, all the allowances set out above).

I'm just surprised it's not more of a benefit, that's all. Obviously there are other benefits to consider for going limited, but from the articles I've read you'd think the average sole trader would save a fortune in tax by switching, but that doesn't seem to be the case in reality. Thanks to everyone for helping me iron out my understanding.

Jeremy535897

The savings only really come where the limited company makes a lot of money that you don't need to spend, so you avoid 40% income tax and pay 19% corporation tax.

Grumpy_chap

The ability to choose the time of drawing from Ltd Co can also be advantageous in avoiding higher tax bands

Sandtree

letsgoagain said:
but from the articles I've read you'd think the average sole trader would save a fortune in tax by switching, but that doesn't seem to be the case in reality.

Many articles are written by people with a vested interest, plus you have a relatively straightforward set of options. Others may be higher or additional rate tax payers; may have a spouse who's not a higher rate tax payer etc where you start to have more potential options. 

gingerdad

at that turnover and profit levels its probably not worth going ltd - you need to be over £35k profit to be better off once you take into account corporation tax etc.