Should I Incorporate?
This is a question we are frequently asked by locums. The answer is “it all depends”.
Self-employment is preferred by many locums because it is a straightforward way to operate with limited formalities in terms of record keeping and compliance.
Using a company on the other hand involves having accounts properly prepared and filed with HMRC and Companies House along with the weight of the Companies Act 2006. And of course the limited company route results in higher accountancy costs.
Despite higher costs and additional compliance, the use of a limited company often results in a lower overall tax liability. As an example, lets consider a fictional locum called Sue whose only source of income is from locum work. Suppose her profits were £40,000 for the year to 5th April 2012. Her total tax liabilities will be £9,585 as shown below:
Tax |
||
7,475 @ 0% |
- |
|
32,525 @ 20% |
6,505 |
|
6,505 |
||
National Insurance |
||
Class 4 |
7,225 @ 0% |
- |
32,775 @ 9% |
2950 |
|
Class 2 |
52 weeks @ £2.50 |
130 |
3080 |
||
Total Tax and NI |
9585 |
|
(So her net income is £30,415 (£40,000 - £9,585).
Now suppose instead Sue had started using a limited company from 6th April 2011 and that company makes up its first accounts to 5th April 2012. Let’s assume that because costs are higher, the profit within the company is £500 less at £39,500.
The most efficient way to use a company is to draw a low salary and distribute the profits net of corporation tax as dividends. The optimum salary level for the year to 5th April 2012 is £7,225, and a person receiving such a salary with no external income can receive up to £31,725 in dividends without paying any income tax personally.
Using optimal tax planning, Sue will be able to generate a net income of £33,045 as shown below:
Profit |
39500 |
Less: Salary |
7225 |
32275 |
|
Less: Corporation Tax |
6455 |
Dividends paid to Sue |
25820 |
Add: Salary received by Sue |
7225 |
£33045 |
So, despite having faced extra costs, Sue’s net income is £2,630 or 8.6% higher as a result of operating through a company.
It has to be said that incorporation is certainly not for everyone. For example, a part time locum generating profits of £10,000 is likely to be no better off because the National Insurance savings will be swallowed up by higher costs. Similarly those who put a high value on the informality and simplicity of self-employment may consider that the tax savings are insignificant. But if your earnings are around the level of Sue, our fictional locum, and you are not put off by a little administration, take advice today!
Disclaimer
This document has been produced for general guidance only and does not constitute tax advice. Whilst every care has been taken in its preparation, Warr & Co will not accept liability for any loss incurred as a result of any use made of this document or its contents. We will be happy to offer specific advice to clients when requested. Should you have any queries or wish to discuss any of the points raised please contact Suresh Dhokia or Peter Edwards on 0161 477 6789.
Date of Article: 14th October 2011
