Historically, if you run a reasonably profitable unincorporated business, it made good financial sense to incorporate it as a company to secure handy income tax plus national insurance savings. By paying themselves a modest salary and taking the remaining profits as dividends, owner-managers could trim personal tax bills thanks to the old dividend regime. But with tightened dividend tax relief lately, have the benefits of switching corporate structure now fizzled out?
How Dividend Taxation Changed
Until April 2016, all dividends included a 10% notional tax credit, reflecting that payouts aren’t deductible expenses for companies. This mechanism meant basic rate taxpayers owed no extra dividend tax. Higher and top-rate taxpayers still enjoyed lower dividend rates versus normal income.
Yet from 2016, this comfy regime crumbled. The tax credit disappeared, swapped for a £5,000 dividend allowance, and later shrunk to £1,000. More painfully, dividend tax rates then increased for higher and extra-rate taxpayers. An extra 1.25% health and social care levy from 2022 has additionally lifted rates.
Slashed Allowances, Swollen Taxes
To demonstrate the impact, let’s compare a sole trader to a one-person company for 2022/23 and 2023/24, assuming £60,000 profits. In 2022/23, the company saves circa £3,000 tax versus sole trading. But in 2023/24, the savings shrivels to £2,250 due to the corporation tax hike. At £100,000 profits, the saving also dwindles from £1,800 to £150. And at £300,000 profits, the sole trader pays £3,250 less tax than the company director! Ouch!
Silver Linings For Smaller Profits?
However, the outlook isn’t wholly gloomy for lower-profit businesses in 2023/24. Firms keeping under £50,000 profit still enjoy the 19% small profits corporation tax rate. Meanwhile, marginal relief cuts the effective tax rate to 26.5% for profits from £50,000 to £250,000.
For instance, a company making £40,000 profit could save an owner-manager around £7,500 tax versus sole trading. Even at £100,000 profits, incorporation potentially saves circa £15,000. Therefore, adopting a company structure can unlock useful tax savings for more compact firms.
Future Upheaval?
Given the ballooning national debt, whether the existing regime will endure in the long term seems uncertain. Further stealthy dividends, salary or corporation tax grabs can fill Treasury coffers. So before incorporating, prudent unincorporated enterprises should model future profit scenarios plus projected tax liabilities as best they can.
If you can reliably forecast perpetual profits under £50,000, becoming a company still makes sense, thanks to the lower corporation tax rate. But for incomes nearing £200,000, expect savings to shrivel rapidly courtesy of the latest tax tightening.