Do Self-Employed Workers Pay Less Tax?

If you’re currently working as self-employed and have decided to set up a limited company, there are several differences in how each type of business structure is taxed. There’s no getting away from it; both self-employment and limited company taxes are complicated.

Read our guide to understand more about the tax benefits of working through a limited company.

Tax for the self-employed and limited company directors

As a self-employed individual, your personal and business finances are treated as one for tax purposes. Your business profits are taxed via the annual self-assessment process, and you pay any income tax owed by 31st January each year.

If you set up a company, your personal finances and those of the company are completely separate entities. So, before any money can be allocated to shareholders or employees, the company itself must pay Corporation Tax on any profits made.

The Small Profits Corporation Tax rate is currently 19% (2022), assuming your turnover is £300,000 or less per year. This tax is payable nine months and one day following the end of the period for which the Corporation Tax returns have been produced.

VAT

If your turnover has reached £85,000 or more during the year, you must register for Value Added Tax (VAT), whereby you must charge VAT on your products or services. You must repay any taxes collected to HM Revenue and Customs, generally on a quarterly basis. You’ll need to register to collect VAT through whichever type of business structure you use (self-employed or limited company) if your turnover reaches the £85,000 mark.

Most limited company contractors with few business expenses often register their company for the Flat Rate VAT Scheme, an incentive introduced by the government to help simplify tax.

For more information on VAT and how to register, take a look at our VAT Guide.

Income Tax

If you’re self-employed, you and your business are viewed as ‘one’ entity by HMRC regarding taxation. You pay income tax via the annual self-assessment process.

The limited company route is more tax-efficient from a personal tax point of view. You will typically take a small salary (with little tax liability) and the remainder of your income in the form of dividends (which are free from National Insurance).

Like self-employed individuals, all company directors have to complete a self-assessment tax return each year. This is when you pay any outstanding personal taxes you may owe on dividends and any other income you may have earned during the year. Don’t forget, your company is taxed separately from you as a director.

National Insurance

Self-employed individuals and limited companies (and their employees) pay different types of National Insurance Contributions (NICs) altogether.

Self-employed workers pay Class 2 and Class 4 NICs, whereas limited companies and their employees pay Class 1 NICs.

Self-employed

Class 2 NICs: If you’re self-employed, you must pay £3.15 per week (2022/23) if your profits are £6,725 or more per year.
Class 4 NICs: These apply to your annual profits and are payable at self-assessment time. You’ll pay 10.25% on profits between £9,881 and £50,270 per year and 3.25% on any profits above this threshold.

Limited company

Class 1 NICs: Both the limited company and its employees pay Class 1 NICs on salaries of more than £190 per week (2022/23). The company pays NICs of 15.05% on salaried income, and employees pay NICs at a rate of 13.25% on salaries up to £967 per week and 3.25% after that.

You should note that NICs are only payable on salaries, not dividends. This is the most important reason why the limited company route is more tax-efficient than being self-employed.

To find out more, take a look at our guide to National Insurance.

Accounting

Whichever business structure you use, you are obliged to keep accurate business records. You may not necessarily use an accountant if you are self-employed with a small number of transactions.

However, almost all limited companies hire accountants as their accounting needs are more complex. A specialist accountant will look after all of your accounts and statutory obligations. So despite what you may have heard, dealing with tax issues isn’t a big deal. You will also pay significantly less tax than you would as a self-employed individual.