When you are planning to become a self-employed locum worker, one of the first decisions you are likely to make is what type of business you will operate – sole trader, partnership, or limited company. We’re going to focus here on the sole trader and limited company routes, and examine some of the pros and cons of each.
If you intend to operate as a sole trader, you must inform HM Revenue and Customs (HMRC) that you are working for yourself within three months of starting out. You are required to pay income tax on all profits your business makes (that’s income earned less allowable expenses), as well as National Insurance contributions. You will have to file a self-assessment tax return each year. If you are likely to earn more than £83,000 per year (current figure for 2016) then you must also register for VAT.
To establish a limited company, you must register with Companies House and also inform HMRC when the company begins trading. If you are likely to take more than £83,000 per year (current figure for 2016) then you must also register for VAT.
A limited company is an organisation that is responsible in its own right; while you can use it as a way to contract your services as a sole director, its finances are separate from your personal finances. You will need to prepare statutory accounts annually and send Companies House a confirmation statement; you also need to send HMRC a company tax return, file a self-assessment tax return, and – if you are drawing a salary – register for PAYE.
Sole Trader Taxation
As a sole trader, you have little control over how much tax you pay. You can make the most of allowances, and tax-free savings schemes such as ISAs, but income tax is charged at a fixed rate. In 2016, income tax thresholds are:
- Personal allowance: £11,000 (tax-free, provided you earn less than £122,000; over that amount there is no personal allowance)
- Basic rate threshold: £43,000 (£11,000 tax-free plus £32,000 taxed at basic rate, currently 20%)
- Higher rate threshold: £150,000 (as above, plus £107,000 taxed at higher rate, currently 40%)
- Additional rate: over £150,000 (as above, with additional income over £150,000 taxed currently at 45%)
Limited Company Taxation
As a limited company, you have more control and more options open to you. You will have to pay corporation tax – currently 20% – on all profits, and also income tax on money you draw from the business as a salary. You will be set up as an employee and use the PAYE system for this. Two immediate advantages are that you aren’t hit with big tax bills twice a year, and also you have a regular salary income to declare when it comes to applying for things such as a mortgage. In addition, however much you draw as a salary is a deductible expense that reduces the amount of corporation tax you have to pay.
As well as your salary – or instead of, if you prefer – you can award yourself dividends from the company’s retained profits. As of April 2016 a new tax-free Dividend Allowance came into operation. Under this scheme, you pay no tax on the first £5,000 of dividend income. After that, you pay tax on dividend income as follows: 7.5% within the basic rate tax band; 32.5% within the higher rate tax band, and 38.1% within the additional rate tax band.
Salary is taxed first, then dividend income. By combining payment types, you can potentially make a saving. Say you currently earn a salary of £60,000. That would break down as:
|£11,000 – tax-free||= £0|
|£32,000 – basic rate (20%)||= £6,400|
|£17,000 – higher rate (40%)||= £6,800|
|Total tax liability||= £13,200|
If, instead, you pay yourself a salary of £40,000 and take the other £20,000 as a dividend, then:
|£11,000 – tax-free||= £0|
|£29,000 – basic rate (20%)||= £5,800|
|£5,000 – tax free||= £0|
|£3,000 – basic rate (7.5%)||= £225 (*see below)|
|£12,000 – higher rate (32.5%)||= £3,900|
|Total tax liability||= £9,925|
(*Basic rate threshold is £43,000; salary income accounts for the first £40,000, leaving £3,000 remaining at the 7.5% basic rate for dividends.)
If you have a spouse or partner, you can also employ them and pay them a salary, which both further reduces your corporation tax liability and enables them to take advantage of their personal tax allowance. They could also receive a dividend.
An accountant will help you set up your limited company, if you choose to, and also work out the optimum mix of salary and dividend. Whichever way you are operating at the moment, it is good policy to review your business type periodically, and certainly do so as circumstances change. If you’re in any doubt, seek professional financial advice.