does it make sense to switch from sole trader to limited company?

deathtocaptcha

I'm a sole trader and doing well at the minute. So well in fact that I'm looking at setting up a limited company to save on tax. I just want to double check that my figures are right and there's nothing blatently obvious I'm getting wrong...

This is hypothetical situation 1:
In 2015 a sole trader will have €40k profit
They'll pay about €11,135 tax according to the calculator here: http://services.deloitte.ie/tc/
Total tax payment will be €11,135

This is hypothetical situation 2:
Mid way through 2015, the sole trader has €20k profit. He decides to set up a company for 2nd half of the year, not taking any salary from the company.
At the end of 2015, the sole trader now pays tax on the €20k he earned of €3,695.
The new company he set up pays 12.5% corporation tax on €20k profit totalling €2,500.
Total tax payment paid between sole trader + company will be €6,195.

Obviously there's some extra hassle / cost involved in running a Ltd company but those costs are all tax deductible anyway so shouldn't be a huge drain.

I'm just wondering if there's anything I'm not seeing? To me it seems like a no brainer to go with option 2, build up company profits and then pay myself a modest salary at a later date. It would give me a more consistent income, some added stability and save €€€€'s in tax payments.

I'm aware that at some stage I'll get taxed withdrawing the company profits (be it in salary or as dividend), but it seems like the smart thing to do (provided you don't need immediate personal access to company profits) is to go with option 2?

Graham

deathtocaptcha wrote: »

at some stage I'll get taxed withdrawing the company profits

You're suggesting 2 tax payments are better than 1???

I'd really, really recommend you go and talk to an accountant.

dbran

It depends on the type of business that you are in whether this senario is relevant. The reality is that you need money to live. Just saying that you will take a pay cut from 40k to 20k is not really realistic. If your lifestyle is such that you will have to pay yourself the extra 20k at some stage anyway then it will be subject to income tax and there will be no saving, maybe even a cost.

It also depends on the nature of the business that you do. There is a professional services surcharge that may be appropriate and if you are caught by this there will be no benefit to leaving the money in the company.

dbran

deathtocaptcha

You're suggesting 2 tax payments are better than 1???

Because the total amount paid will be significantly less, yes...

If your lifestyle is such that you will have to pay yourself the extra 20k at some stage anyway then it will be subject to income tax and there will be no saving, maybe even a cost.

It also depends on the nature of the business that you do. There is a professional services surcharge that may be appropriate and if you are caught by this there will be no benefit to leaving the money in the company.

I should have clarified, I can afford to live on savings for 6 months.... Professional services surcharge is a good point (in this example it would be a 15% surcharge on €10k) - in situation number two it would bring total tax paid to €7,695, but even with that, the savings of operating a company still appear to be significant?

€11,135 -v- €7,695 = €3,440 saved by going the company route... (i'm fully aware I'd have less personal income in the short term and that would be the sacrifice necessary to make it happen)

Graham

deathtocaptcha wrote: »

€11,135 -v- €7,695 = €3,440 saved by going the company route... (i'm fully aware I'd have less personal income in the short term and that would be the sacrifice necessary to make it happen)

How does that stack up when you take the retained profits out of the company?

deathtocaptcha

Graham wrote: »

How does that stack up when you take the retained profits out of the company?

I wouldn't... I'd just pay myself whatever salary I need to live on...

let's say retained profits at end of 2015 were €20k... at the start of 2016, i'd pay myself €400/week or something to that effect, meaning i'd have a steady, consistent wage / personal cashflow regardless of how business is doing week to week...

it just doesn't seem to make sense to me (if i'm spending less than i'm earning) to keep money in a personal savings account when i can keep *more* of it in my own company... but i'm open to being corrected and appreciate the comments so far...

dbran

That's the flaw in your plan. You are totally ignoring the fact that you can't take the remaining money out without paying income tax or cgt in the end. All you are doing is postponing the tax. Paying less "today" but most likely paying more in the long run overall when you finally take the funds out.

deathtocaptcha

dbran wrote: »

That's the flaw in your plan. You are totally ignoring the fact that you can't take the remaining money out without paying income tax or cgt in the end. All you are doing is postponing the tax.

I understand, but it buys me time to think about investing it / expanding business to other areas etc... It would also in theory allow me to take the money out in a 'bad' year for the business...

i.e. let's say in 2016 I've got €40k profit in a company account... if in 2017 for some reason the company makes a loss i.e. my hypothetical €20k salary exceeds whatever the company makes, then i can still pay myself the €20k (which gives me stability).

the personal tax paid overall (as an employee) over the two years would be lower than taking the full amount out in one year...

so again an example as a company employee:
2016: €20k salary = €3,695 paid in tax
2017: €20k salary = €3,695 paid in tax

or if i were to pay myself a €40k salary in one year only
2016: €40k salary = €11,135 paid in tax

It just seems that *if* i'm prepared to take a low salary and build up company profit, the tax savings are significant... i agree at some stage i'll probably want to take more out but the stability is more important to me in the short term i.e. if i can pay myself x per week and live on it, i'm happy. I can gradually increase it over time..

Graham

It's an odd approach, it's like your financially planning for minimum wage.

I was going to ask if you'd factored in the costs of running the limited company but I'll revert back to my original suggestion. Go and talk to an accountant.

pedroeibar1

deathtocaptcha wrote: »

It just seems that *if* i'm prepared to take a low salary and build up company profit, the tax savings are significant... .

Total lack of understanding of taxation. The tax savings are not significant, what you are doing is actually increasing the taxation level by paying corporation profits tax and then having to pay income tax when you take the money out or capital gains when you sell the business.

deathtocaptcha

pedroeibar1 wrote: »

Total lack of understanding of taxation. The tax savings are not significant, what you are doing is actually increasing the taxation level by paying corporation profits tax and then having to pay income tax when you take the money out or capital gains when you sell the business.

But the way i see it is that it's better to have €20k sitting in a company savings account than have €17k sitting in a personal savings account... (i'm not going to touch the money either way).

Firstly, it gives me a cushion / safety net to pay myself even if i've got no business coming in. Secondly, it allows me to pay myself a steady wage (which makes personal budgeting and cashflow easier). Thirdly, if i were to start investing that money, i'd have an extra 3k to play with... which over time could make for some nice compound interest...

Yes I know i can't take that €20k out tax-free, but i can pay it to myself by gradually increasing my salary which ultimately means i'd pay less personal income tax if i'm restricting my salary to avoid a high rate of personal tax (40%)...

I can't do that sort of juggling as a sole trader - if for example a sole trader profits €100k this year, they pay about €42k in tax and that's that. That's all great if they want / need to have access to it all, but because i can live on half of what i'm earning at present, it really doesn't matter to me whether the money i'm not spending is quickly accessible or not.

From a personal finance perspective, I could live on savings for about 2 years if that helps you understand my position any... which is why i'd be happy to forgo a salary for 6 months and build up company profits... I'm in my 20's, no debt, not going near houses / mortgage / marriage any time soon and all i really have to worry about is rent / regular household bills, car / food / the odd holiday... nothing major.

I'm pretty sure i understand the points everyone is making and i will seek professional advice shortly, but i'm still convinced what i'm trying to do makes financial sense and although i know most people here don't think it's a wise move, i still think the numbers add up... it hinges largely on:

(a) not needing a salary for 6 months.
(b) being willing to accept / live on a minimum wage salary starting next year.
(c) being comfortable with company retaining most of the profits.
(d) being comfortable with company distributing profits gradually in the future through modest salary increases and not in giant lump sums / dividends.

I understand that may sound incredibly strange to some people but personally i think it forces me to not to be wasteful and also gives me a consistent salary regardless of how much work i have on (which is peace of mind).

Graham

Open a credit union account and you can achieve pretty much everything you've listed above without kidding yourself you've discovered some ground breaking tax-saving scheme.

deathtocaptcha

Graham wrote: »

Open a credit union account and you can achieve pretty much everything you've listed above without kidding yourself you've discovered some ground breaking tax-saving scheme.

I don't get the hostility? I'm just running the numbers on different options and believe it makes more sense to go down the company route.

From what i'm reading, people don't think it's sensible and list reasons why, but those reasons aren't applicable in my case and I've outlined why (i.e. i don't need a salary initially and don't need to withdraw the cash in large lump sums).

Fast forward 10 years and as a sole trader earning €40k/year at current tax rates, i'd have earned €400k and paid €111k in tax...

Taking a €25k salary from a company, keeping profit in the company and paying professional services surcharge, here's how things would stand:

As company employee: €250k earned, €52,450 paid in tax
Company: €15k profit yearly minus 12.5% tax = €1875. Also minus professional services surcharge of 15% on €7.5k = €1125. So €15k minus taxes = €12k retained profit after tax. Multiplied by 10 years = €120k profit.

So as an individual sole trader i'd have a net of €289,000
As an employee owning the company id have a net of €197,550 but i'd also have €120k in the company... (but obviously investing it / with compound interest, i'd expect it to be more)...

Am i going mad here??! Are my figures not correct?! To me the second option is the most sensible *provided you can afford to take the lower salary* which I've already stressed I can do for the forseeable future...

Graham

There's no hostility, it just doesn't make sense.

To complete the story you need to work out what happens in year 10. How much is left after you've paid tax on your €120k when you take it out of the company. What's inflation going to have done to your retained profits? Have you factored in the administrative costs for an accountant/annual returns etc? Will your bank charges increase as a Limited company rather than a sole trader?

Tiddlypeeps

I can see what you are getting at. Why pay 40% on the amount at the higher rate when you might end up with a salary under the marginal rate next year or the year after due to having a bad year.

If you do encounter a bad year in the next few years then this tactic will likely save you a few euro. But if you have all good years then you are actually gonna put yourself in a position where you are likely to pay quite a bit more tax, so it's a big risk. If say 5 years down the line the company has made 50k per year, and you only take 20k out for yourself each year. Then at the end of the 5 years you decide you need a large sum of money for whatever reason, mortgage or whatever, you will have 150k (minus whatever the corporation tax would have been, too lazy to do math) sitting in the company coffers ready to be pulled out. You will pay a lot more tax on this at that point than had you just paid it all out to yourself in a salary and paid tax on it at the time because of the higher tax rate on top of the corporation tax you would have paid on it year to year. It would be (33,800 - 20,000)*5 that you would have to pay the higher rate on that you wouldn't have otherwise.

If you genuinely expect to encounter bad years ahead where you wont' be able to afford your salary, or you expect to expand in the future and want to save money within the company for that then I recommend you pay yourself up to the cut off point for the lower rate of tax, 33,800. That way if you do end up with the scenario above you will only have lost the corporation tax, and won't be paying any extra on the higher rate than you would have if you paid it all year to year. It's still a risk tho.

Do talk to an account tho to see if this is actually a good idea for your company. It depends on what your projections are and how stable your industry is, what your plans for expansion in the future might be or the likelihood of unexpected company costs etc etc. They should be able to help you work all that out. The accountancy fees of going Limited can be non trivial as well, so be sure to get quotes and factor them into the decision.

deathtocaptcha

Graham wrote: »

There's no hostility, it just doesn't make sense.

To complete the story you need to work out what happens in year 10. How much is left after you've paid tax on your €120k when you take it out of the company. What's inflation going to have done to your retained profits? Have you factored in the administrative costs for an accountant/annual returns etc? Will your bank charges increase as a Limited company rather than a sole trader?

Yep and that's a valid point, it's something I've thought about and I can't forsee a situation where I need to withdraw a massive lump sum for something personal. Mortgage is the obvious one but even that will be based on salary and a steady consistent salary is much better than something spikey and inconsistent (which tends to be the way when operating as a sole trader). But for various reasons buying a house will be *at least* 5 years off for me, probably much more.

I know the numbers are dumbed down a good bit and don't take in to account inflation or changes to taxes etc.. i.e. i'd be an idiot to keep that sort of cash in a savings account when i could be putting some / most of it to work in investments and beating inflation...

If you do encounter a bad year in the next few years then this tactic will likely save you a few euro. But if you have all good years then you are actually gonna put yourself in a position where you are likely to pay quite a bit more tax, so it's a big risk.

Yep, it is a risk in that the better I do, the more tempting it will be to increase salary or withdraw lump sums... i like your idea of paying myself up to the cut off point of €34k-ish and that's something i'll explore further as it would further reduce the need / temptation for me to withdraw lump sums.

I'm in IT so fairly safe and it's quite possible I could need to contract work out at a later date so expansion could be necessary.

Anyway, thanks for all the help guys and I've got lots of food for thought and questions / scenarios to put to an accountant...

pedronomix

This is probably the saddest effort at tax planning that I have ever seen. It does not seek to reduce tax and is most likely to be more onerous in terms of tax paid in the longer term. Focus on reducing tax payable and not tax payment timelines!!

IpreDictDeatH

I wonder can anybody suggest good books or reading material on this subject as I'd like to become more knowledgable myself. I don't see much info online on this subject, specifically on how best to manage money created by a business to increase personal wealth.

Take2Sean

I like the limited company option but not for tax reasons. Other posters are righth you're basically delaying paying and eventually you'll have to pay. There are pension schemes etc to avail of as a company director. But I think you should be considering the other benefits of Ltd. Most notably liability.

Running an Ltd. I find bank charges to be fairly minimal but I don't do tons of small transactions or take card payments and the likes so I'm probably not in the normal charges bracket in that sense. Accountancy fees outside Dublin anyway (Munster etc) should be about €2000/€3000 a year if you keep good records and I suppose depending on business type.

You should really be basing it on your long term plan. Make money and have t yourself always or go down the build a company route and use it to grow your wealth. There's other things like are you likely to be sued ever. An accountant with all the details of your business should be able to tell you easily what the best option for you is.

pedronomix

Take2Sean wrote: »

I like the limited company option but not for tax reasons. Other posters are righth you're basically delaying paying and eventually you'll have to pay. There are pension schemes etc to avail of as a company director. But I think you should be considering the other benefits of Ltd. Most notably liability.

Running an Ltd. I find bank charges to be fairly minimal but I don't do tons of small transactions or take card payments and the likes so I'm probably not in the normal charges bracket in that sense. Accountancy fees outside Dublin anyway (Munster etc) should be about €2000/€3000 a year if you keep good records and I suppose depending on business type.

You should really be basing it on your long term plan. Make money and have t yourself always or go down the build a company route and use it to grow your wealth. There's other things like are you likely to be sued ever. An accountant with all the details of your business should be able to tell you easily what the best option for you is.

Is this post intended to add something? I am lost, if so!

Take2Sean

This forum is actually the most negative thing I have ever been on....it's literally 90% lads just waiting to have a go at anyone that posts anything. F*^king hell....

newmug

Yep. Its fairly snarky. Thats totally unnecessary. A young lad is asking for business advice of those who likely know more than him, but they're just being nasty. No need for it.

Good on you OP. I wish I was in a position like yourself. Option 2 sounds nice if you were getting mostly cash

dbran

Guys

Calm!

I think the OP has got all the information that he needs to make a decision.

So as I dont think anyone has anything more to add that hasnt already been said (or is worth saying) I'm going to close this thread.

Dbran