Starting your own business and need help deciding what structure is best? Are you a Sole Trader wondering if you will pay less tax if you set up a Limited Company?
Paying tax as a Limited Company is a very popular topic because business owners want to ensure they’re tax-compliant and also, tax-efficient. This means making sure you’re setting up your Limited Company in the correct way so you can save on your tax bill at the end of the year.
We know it can be confusing to decide between Sole Trader or a Limited Company, so in this guide, we explain the differences between the two structures and answer the question; will I pay less tax if I’m a Limited Company?
How much tax do I need to pay?
Depending on how much you earn as a Sole Trader, you can pay up to 52% tax on all your earnings.
Compare that to a Limited Company that pays 12.5% Corporation Tax on company profits.
The main difference here is that a Sole Trader pays the same rate of tax on all their earnings because they don’t take a salary. Everything a self-employed person earns is essentially their income and therefore subject to Irish income tax rates.
On the other hand, a director of a company can take a salary or dividend, which is a business expense, and therefore, deducted before the company profits are calculated.
This means that business owners who earn more than they require to live on will generally pay less tax if they incorporate a Limited Company.
Limited Companies can plan their salary to reduce tax liability
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Salary
A salary is a fixed annual payment to an employee or director at regular intervals, e.g. weekly or monthly. The payment amount is decided by the company and so, if a director decides to take a salary, they can make sure to pay an amount that falls below the higher rate of income tax.
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Director's fees
Directors can receive payment for activities relating solely to specific director duties. For example, attending meetings if they are not an employee of the company.
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Dividends
Dividends are regular payments (normally once a year) by a company to its shareholders out of its profits or reserves. It's important to note that a director can not take dividends unless they are also a shareholder in the company.
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.
For example, any employees or directors that work away from their normal place of work can be paid tax-free travel and subsistence payments. 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 travelled.
It’s important that any related receipts are recorded and organised correctly in case of a Revenue audit. Proper bookkeeping is vital when claiming expenses and ensuring the company is declaring the correct amount of tax.
Making pension contributions to reduce your tax bill
It can be tax efficient for a Limited Company to contribute to a pension for an employee or 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 the company and its directors can 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.
This is an example calculation and 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 her earning minus 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 minus expenses and salary, in this case, €50,000 taxed at 12.5% corporation tax.
| Lucy Sole Trader | Joe Limited Company | |
| Turnover | €90,000 | €90,000 |
| Expenses – e.g. rent, light, heat, etc | €10,000 | €10,000 |
| Gross Salary – Limited Company | – | €30,000 |
| Net Salary* | – | €25,388 |
| Corporation Tax | €6,250 | |
| Personal Tax on Wages | €28,901 | €5,078 |
| Total Tax | €28,901 | €11,328 |
| 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 | – |
| Net Drawings* | €51,099 | – |
| 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 that 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.
Limited liability
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.
Raising capital
If you are a Sole Trader, your only way of raising extra finance may be a bank loan or overdraft. 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.
Still have questions?
If you are currently contemplating the ideal company structure for your business, it is crucial to thoroughly evaluate the pros and cons of a company, such as the potential tax benefits. As an entrepreneur, seeking clarity on the tax implications of your business endeavours is natural. This concern becomes even more prominent for Sole Traders transitioning into a Limited Company, as the growth of your business also raises your awareness of the accompanying tax liability. Understanding the tax advantages associated with a Limited Company structure can provide valuable insights and help you make an informed decision that aligns with your business growth aspirations.
Larissa is a Fellow Chartered Accountant (FCA) and is the CEO of Accountant Online, which specialises in company formation, company secretarial, annual accounting services, bookkeeping, tax, and payroll services for micro and small companies in Ireland and the UK.
