We are often asked, how much does it cost to set up a limited company? The truth is that it can be much less than you imagine. There are however a few differences in the financial terms between working as a sole trader and a limited company, in this article we’ll discuss these. This includes the tax you need to pay and the cost of setting up a limited company. It also includes the ongoing management of your business and your own financial liability.
Self-employed tax
If you choose to set up as self-employed you will run your own business as an individual and both your business and personal taxes are treated as one. You must register with HMRC to complete a Self Assessment tax return every year and you will pay income tax (see here for the latest rates) and National Insurance on your profits (See here for the latest rates).
Income Tax
Income tax rates can change every April. You can find the most up to date Income tax rates on the government’s website here. The current income tax rates for 2022/2023 are:
| Band | Taxable income | Tax rate |
|---|---|---|
| Personal Allowance | Up to £12,570 | 0% |
| Basic rate | £12,571 to £50,270 | 20% |
| Higher rate | £50,271 to £150,000 | 40% |
| Additional rate | over £150,000 | 45% |
It’s worth noting that there are marginal bands on self-employed income tax. This means that if your salary puts you in the higher rate tax band, you will only pay 40% on the earnings in that particular tax band. For example, if you have a £60,000 salary, you will pay 0% tax on the first £12,570, 20% on your salary that falls into the basic rate (£12,571 to £50,270) which means you’ll pay 20% tax on £37,700 and then 40% on what falls into the higher rate tax band which means 40% tax on £9,730.
National Insurance
Like income tax, National insurance rates can change every year, to find the most up to date information on National Insurance rates if your self employed on the government’s website here. The current National Insurance tax rates for 20221/2022 are:
| Class | The rate for tax year 2021 to 2022 |
|---|---|
| Class 2 | £3.15 a week |
| Class 4 | 10.25% on profits between £9,881 and £50,270 3.25% on profits over £50,270 |
You pay Class 2 if your yearly profits are £6515 or above and you pay Class 4 if your profits are £9,569 or more a year. As of April 2022, National insurance rates will increase by 1.25%
VAT
Whether you have a sole trader business or a limited company you will also need to register your company for VAT if your taxable turnover is more than £85,000 in 12 months. This means for the majority of sales, you will need to charge 20% VAT. This will not change for the next 2 years.
Once you register for VAT you can normally claim back VAT on purchases that are used solely for business purposes, but when doing this you should seek professional advice.
There are also new rules that were put in place on the 1st of January 2022 regarding filling VAT tax returns. The government stated that you need to use a ‘Making Tax Digital approved software’ to submit any VAT returns and keep VT records. You can find out more about this in our blog post here.
Limited company tax
As a limited company, you have chosen to set your business up as a separate legal entity, distinct from yourself and the other shareholders and directors. Although the cost of setting up a limited company can be lower than you think (check out our formation packages), your tax responsibilities are different from being a sole trader.
Corporation Tax
Corporation tax is a tax on a limited company’s profits after its business expenses such as salaries etc. If a limited company is not in profit, Corporation Tax does not apply.
If your company is in profit, you will need to put together statutory accounts for your business and send Companies House an annual return. You’ll also need to send HMRC a company tax return. This is so that Corporation Tax can be calculated on your business profits. The rates can change every year, but for 2021/2022 the Corporation Tax rate is 19% on all profits. You can find the most up to date Corporation tax rates on the government’s website here.
It’s worth noting that in 2023, there will be a change in Corporation Tax. A company that has a profit of under £50,000 will pay 19% Corporation Tax (the same as it now), however, if a company has profits of over £50,000, Corporation Tax will be 25%. This can be reduced if the business profits are between £50,000 and £250,000 due to marginal relief. You can find more info on this here.
NICs for a director
As a director is technically classed as an employee of a limited company, this means they pay Class 1 primary National Insurance. What this means is they pay NICs on annual income from salary and bonuses over a threshold. Director NICs are worked out from their annual earnings rather than from what they earn in each pay period and are subject to change. You can keep track of the current National Insurance rates thresholds here.
Employers NICs
If you employ people through your limited company, you will also need to pay employers NICs through your PAYE bill. This means that if you pay employees over the annual threshold, you will have to pay NICs on their salary. This also applies to a director’s salary, and again are subject to change, so you can find the latest rates and thresholds here.
Divided Tax
As a director of a limited company, you do have the option to pay yourself in dividends if your company is in profit. The first £2,000 you get through dividends is tax-free, but anything above that, the amount of tax you pay depends on your income tax band.
- Basic rate = 8.75% tax on dividends
- Higher rate = 33.75% tax on dividends
- Additional rate = 39.35% tax on dividends
Please note, that all the above tax information is guidance and can change depending on the Government’s actions and your situation. You should seek professional help from an accountant when dealing with tax.
Administration and the cost of setting up a limited company
Whether you’re setting up as self-employed or you’d prefer to start a limited company there isn’t a huge difference in cost. Using a formation agent can bring the cost of setting up a limited company to nearly nothing. With The Formations Company’s E-Formation package the cost of incorporating your company can cost less than if you were to go directly to Companies House! We can even take care of all the admin for you with our more expensive packages!
The administration differences between self-employment and being a limited company
One of the big differences between being self-employed and running a limited company is the administrative obligations. In general, when you are running a limited company you have to complete more returns. However, many of the details you need to file for a limited company are details you also need to help make your sole trader business successful too.
As a limited company…
- You will need to keep company and financial records
- Report any changes to Companies House and HMRC
- And to file an annual return and a copy of your company’s accounts. This makes sure they give a ‘true and fair view’ of its finances.
As a director of a limited company…
- You must try to make the company a success
- To make decisions that are for the company’s benefit rather than your own
- And to tell other shareholders if you might personally benefit from a company transaction.
- You will also need to follow the rules laid down in the company articles of association.
For many businesses, whether limited companies, sole traders or business partnerships, these tasks, returns and communications are taken care of by an accountant. This means, other than ensuring that they happen, they are not a big trouble.
Your business and your liability
When you form a limited company you are, in effect, limiting your personal liability. This makes sure that if something goes wrong with the business, whether that’s debt or a claim has been made against your company, your personal assets and finances will not be at stake, thus protecting you personally from financial implications.
As a sole trader, or if you’re in a business partnership, this is not the case and you will be personally liable for your business. This means if your business is sued, and you don’t have enough money in the company to cover the amount, you might have to sell possessions such as too, your car and even your home to cover the costs!
Bringing the cost of setting up and admin of a limited company down
So, how much does it cost to set up a limited company? Not much money nor time. The Formations Company lays out each step in the process for you and your incorporation can take as little as 24 working hours to complete. You can also choose from a number of different packages, offering basic formations for just £9.99 right through to everything you’ll need for £149.99 a year!