Something strange is going on with small businesses. Data published last week by the Office for National Statistics shows that the number of sole traders in the UK fell 4% last year – and has now declined 11% since 2019; by contrast, the number of small-business owners operating through companies rose 1% in 2023 and is up 4% on five years ago. The data feels counterintuitive because tax changes have made it progressively less attractive to run your business through a company structure in recent years.
In other words, some small-business owners may be paying more tax than they need to – possibly, say small-business experts, because the rules are poorly understood. Certainly, there are advantages to incorporating your business rather than operating as a sole trader. In particular, company owners aren’t usually personally liable for losses or liabilities incurred by their businesses, unlike sole traders. A company structure can also make it easier to navigate the IR35 rules on disguised employment, which have made life more difficult for contractors in recent years.
However, it is the tax position that is usually front of mind for small-business owners weighing up the pros and cons of incorporation versus sole trader status. And here, the scales have tipped in recent times. As a sole trader, you’ll pay income tax on the profits you make from your business – at a top rate of 20%, 40% or 45%, depending on whether you’re a basic-, higher- or additional rate taxpayer – as well as national insurance.
MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
By contrast, if you trade as a company, it will pay corporation tax on profits, at rates from 19% to 25% depending on how much it makes. However, you’ll also need to take money out of the company as your earnings, either by paying yourself an income or through dividends. You’ll pay the usual income and national insurance rates if you opt for income, or dividend tax rates on dividends – 8.75%, 33.75% or 39.35% for basic-, higher- or additional-rate taxpayers.
Taxes for a sole trader
The combination of corporation tax and further taxes on earnings means that, for many small-business owners, operating through a company leads to a higher tax bill than working as a sole trader. And that has become much more likely in recent years, following increases in both corporation tax and dividend tax rates, as well as reductions in the tax-free dividend allowance. By contrast, income tax rates have been left untouched.
Some small-business experts are worried that the impact of such changes has been poorly understood. They fear that the idea of a company offering greater tax efficiency has become ingrained among entrepreneurs, even though it is no longer the case for many small-business owners. For individual owners, there is no single right answer.
But it does make sense to review your business’s tax position – perhaps after the Budget later this month – to check that you’re not putting yourself at a disadvantage. An accountant can help you analyse the figures under both structures, and then you can consider other advantages and disadvantages. Equally, for new business founders, don’t assume that incorporation is always the right route to go down.
This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
-
What makes you wealthy in the UK? Could it make you a target in Rachel Reeves’ Budget?Wealthy Brits could be at risk from a Budget tax raid – but how much money do you need to be considered wealthy in the UK?
-
More retirees are buying inflation-protected annuities. What are they and how do they work?Sales of annuities where the income on offer increases every year have surged – and more people are also taking up enhanced rates that are higher due to illness
-
'Gen Z is facing an AI jobs bloodbath'Opinion It has always been tough to get your first job, but this year, it's proving tougher than ever. AI is to blame, says Matthew Lynn
-
Beazley: a compelling specialist insurerThe insurer Beazley is unusually profitable at present, and that looks set to continue. The stock is also a valuable portfolio diversifier, says Jamie Ward
-
Is Britain heading for a big debt crisis?Opinion Things are not yet as bad as some reports have claimed. But they sure aren’t rosy either, says Julian Jessop
-
What is the Enterprise Investment Scheme and should you have one?The Enterprise Investment Scheme is tax-efficient and potentially lucrative. Taking a chance on the scheme could trim your family’s IHT bill, says David Prosser
-
What are wealth taxes and would they work in Britain?The Treasury is short of cash and mulling over how it can get its hands on more money to plug the gap. Could wealth taxes do the trick?
-
Self-employed? Start saving for your pension nowBritons who are self-employed have neglected to build up their retirement fund. They must act now
-
Why is Britain's industrial base crumbling?Opinion More and more factories in the UK are closing, and the government doesn’t seem to care. What’s going on?
-
Scotland's former first minister Nicola Sturgeon leaves behind a toxic legacyOn the left, Nicola Sturgeon is seen as something of a political hero. That makes sense… but only if you exclude her actual record in office
