Will I pay less tax if I am a Limited Company?
You might be a Sole Trader wondering if you will you pay less tax if you set up a Limited Company, or you might just be starting up your business and you want to know which structure is best for your business.
We know it can be confusing, so in this guide, we will explain the differences between the two and answer the question; will I pay less tax if I’m a Limited Company?
Is your business generating more profit than you need to re-invest back into it? Are you ready to set up as self-employed?
If so, setting up a Limited Company may be the most tax-efficient way to structure your business.
12.5% Corporation Tax
As a Sole Trader, you will pay up to 40% tax on the profits which your business makes. Add USC and PRSI and your total tax rate jumps up to 52%. Compare that to a Corporation Tax rate of 12.5% on company profits, plus PAYE tax on whatever salary you earn as an employee of the company. Therefore, you will generally pay less tax if you incorporate a Limited Company where business profits are higher than what you require to live on.
Let’s Break It down to make it a little clearer…
Less tax on pay
An incorporated company has more flexibility in paying employees and directors, such as a salary, directors’ fees and dividends. A director can receive payment for attending meetings if they are not an employee of the company.
A salary is a fixed annual payment to an employee or director at regular intervals. A shareholder cannot take a salary without also being an employee of the company.
Dividends are regular payments (normally once a year) by a company to its shareholders out of its profits or reserves. A director can not take dividends unless they are also a shareholder in the company.
Dividends are an attractive alternative to salary for many non-proprietary directors, as the company does not have to pay employer PRSI on the dividends. If you are a resident company in Ireland, you will need to deduct Dividend Withholding tax from gross dividend payments, at a rate of 20% and pay this to Revenue.
Are your tax returns due this year?
If you are a Sole Trader and you have been trading since 2018, you will have to file a self-assessed Income Tax return and pay your tax liabilities before the 31st October 2020.
Tax free expenses for Employees and Directors
A company may also pay proper business expenses to employees and directors – at civil service rates – on a tax-free basis. have a look at other tax-free vouchers that you can give to your employees.
Companies may make tax-free travel and subsistence payments to employees and directors, on any days which they work away from their normal place of work. The length of time spent away from the normal place of work determines the tax-free amount. In addition, a company may pay a certain percentage of the cost of every business journey taken in a private vehicle, based on the distance traveled.
Less tax on pensions
It can be tax efficient for a Limited Company to contribute to a pension for an employee or a director. This could be an executive pension or a small self-administered pension (SSAP).
These pension contributions are not subject to the same limitations as personal pension contributions. Therefore, they can be a very efficient tax planning tool for the longer-term future of your employees and directors.
Both company and director alike enjoy tax benefits from employer contributions to pension schemes.
Payments made by the company into the directors’ pension fund are allowable as a deduction against trading profits which are subject to tax. There is no tax on this benefit for the director. The value of the fund will grow, and it will only become taxable on retirement. The pension fund could also pass on as part of a will.
Example of the tax differences between a Sole Trader and a Limited Company
Below is an example of a Sole Trader owner and a Limited Company owner/director who are resident in Ireland. If you are a non-resident director, there are different treatments of dividends depending on which country you are from. We used taxcalc.ie to calculate salaries based on 2018 Budget, using the example of a single person in their 30’s. Check out our Sole Trader or Limited company guide for more information to help you choose the right structure for your business.
We advise that you talk to your accountant about your individual circumstances to get more insight into your personal situation.
– Lucy is a Sole Trader with profits of €90,000. She will pay tax on all the profits in less expenses, which in this case equals €80,000.
– Joe is the director of a Limited Company who has company profits of €90,000 and takes an employee’s salary of €30,000.
– The combined taxes on his employee’s salary – including PAYE, USC, and PRSI – would come to about 16%.
– He then pays less tax on company profits less expenses and salary, in this case, €50,000 taxed at 12.5% corporation tax.
|Lucy Sole Trader||Joe Limited Company|
|Expenses – e.g. rent, light, heat etc||€10,000||€10,000|
|Gross Salary – Limited Company||–||€30,000|
|Personal Tax on Wages||€28,901||€5,078|
|Note: the taxable profit for the sole trader is deemed salary|
|Drawings i.e. salary for a Sole Trader. (Total of what remains of your turnover after expenses)||€80,000||–|
|Remaining turnover after 12.5% Corporation Tax on profits in the Limited Company||–||€43,750|
|Net Income for the individual||€51,099 in net drawings||€25,388 in net salary for the director|
|Net Income for the business||–||€43, 750 in profit for the business|
Other advantages of becoming a Limited Company
Separate Legal Entity
As a Sole Trader, if someone takes legal action against your business, they sue you personally. In the case of a Limited Company, it is the company which is normally the subject of a lawsuit. As an employee of the company, you are no more open to a personal lawsuit than any other employee.
As a shareholder in the business, you are liable for the amount of Issued Share Capital you own i.e. what you paid for your Shares. Please note, however, that company directors often have to underwrite bank or other company loans so may have extra liabilities in this way. Click here for details and other exceptions.
If you are a Sole Trader, your only way of raising extra finance may be by a bank loan. Limited Companies, however, can raise capital by issuing shares to investors, who then buy into your business.
Increase Business Credibility
Some owners feel it increases business credibility if you are seeking business from the large corporate or the public sector. Sometimes these larger corporate businesses often insist that you operate as a Limited Company.
Pros and Cons of Sole Traders and Limited Companies
If you’re still unsure about setting up as a Limited Company, check out our Sole Trader vs Limited Company pros and cons.