Basic tax position Employee vs Limited Company

[Marshall_Clegg]

Hi,
I will possibly be moving into the world of IT contracting soon and am trying to get a feel for what I would take home compared to my current situation as an employee.

My very limited understanding is that, with a Limited Company, the company will pay corporation tax on profits and then the individual will pay tax on dividends that the company pay out.

Starting at that basis, I think that there are several expenses that the company can claim which reduce the corporation tax paid (because they are deducted from the profit).

However, assuming a situation where I earn £70,000, and have negligible expenses to claim.

My take home pay as an employee under PAYE would seem to be about £4,200

I did the following calculations on a corporation tax/dividend tax instead

Profit - £70,000
Corp Tax (@ 21%) - £14,700
Net Profit - £55,300

Dividend - £55,300
Allowance - £34,800
Taxable dividend - £20,500
Dividend tax (@ 23%) - £4,715

Dividend after tax - £50,585
per month - £4,215

So, the per month figure is pretty much identical to the figure taken as an employee under PAYE (assuming that the money is taken out of the company each year in the way of dividends).

Now, I am just trying to get a basic overview so that I can drill down into specifics as I learn more. So I wondered if anybody could please tell me if the above calculations look about right, or whether I have missed something fundamental?

If the figures are right, am I generally correct in thinking that the main difference will be that the limited company can offset expenses, and that if I have few expenses the real gap between PAYE vs Limited Company will not be substantial.

I know that there is a lot of details to go through, and I am preparing myself to spend a lot of time studying those details - but I am hoping to just get an idea of the basics here as a start point.

Any help would be greatly appreciated.

Many Thanks,
Marshall

[lje]

I suggest that you take a look at the first timers guide.

Your figures are wrong on a number of counts.

1. You would have expenses. For example an accountancy charge. Also, you would probably pay yourself travel expenses (eg 40p per mile driven for the first 10,000 miles).
2. Most accountants would suggest that you pay yourself a salary. Their suggestions are likely to vary from just enought to qualify for NI (somewhere around £5,500pa) and national minimum wage (somewhere around £12,000). As your limited company would be employing you there would be employer's national insurance to pay as well as employee's. Of course, there may also be income tax depending on how much salary is paid. The taxes and salary costs come off your revenue before profit is calculated.
3. Your company could choose to contribute to your pension. This money would come off revenue before profit is calculated.
4. You would then pay corporation tax on the remaining profit.
5. Any dividends you take which keep you below the 40% income tax limit will not be further taxed as you have already paid corporation tax. They come with a tax credit. If you take enough money out to go above the 40% tax limit then you will need to pay extra tax on the proportion of the dividends which take you over.

There are lots of other things to consider too. If you're inside IR35 then the calculation is completely different. If you don't know what IR35 is then go back to the first timers guide.

Finally, it makes sense for you to search for answers to specific questions in the forum before asking anything. Then if you still have a question post it.

[northernladuk]

Good answer!!! Well worded, informative and articulate.. are you sure you are supposed to be here??

There are many posts asking something similar to this, mainly about % take home. All have many poor assumptions in making the whole exercise a bit pointless. Many also refer you back to you accountant as that is their job.

You assume negligble expenses but this will rarely be the case and something is wrong if it is. Negligble expenses isn't good! You have expenses as a permie which come out of your pocket so just as imprtant they are considered here to reduce your tax liability. PC's, travel, consumables, 5quid a day meals. It mounts up.

Second horrible assumption is you will be in a contract for a year. As you can see on the board the reality is likely to be very different. This will just throw your figures right out of the water and the exercise is irrelavent.

It looks more like you are trying to do a forecast than actually understand your accounts. As mentioned there is some good reading but as you are so new get yourself an accountant. If you can't get the basics then I am sure he will prove his worth weight in gold the first year and pay for himself.

[northernladuk]

Oh sorry yes there is something fundamental as well. I knew something was nagging me.

If you are leaving a £70k a year permie job to go get £70k a year contracting you want you head examining.

If you are leaing a £70k a year permie job to do any contracting right now needs a good long sitdown and think as well. There are a lot of people here would swap to permie right now.

You need go and look at the contracting market first, decide if it is worth the risk, if it is research the roles and get the proper rates for a similar role and THEN do your sums.

I would guess if your on 70K a year you would be looking for well in excess of 100K to make the risk pay off. Makes your sums a look a tad healthier (risk and assumptions included of course)

[malvolio]

WHS. As a rule of thumb, £70k pa permie is £70 an hour contracting, or around £550 a day. I doubt you will get that in this market, and I doubt you'll be gettting it for a year.

Don't freelance for the money, it's simply not there. Do it for real reasons.

And you will be amazed at how much you don't know so read the guides, the one here, the PCG Firstimers Guide on www.pcg.org.uk and the SJD one which talks about finances. Then you can ask intelligent questions about the detail.

[lje]

Good answer!!! Well worded, informative and articulate.. are you sure you are supposed to be here??

I obviously haven't been on here for long enough... How long does it normally take before people's answers become 'Just use the search facility you ****'?

[malvolio]

I obviously haven't been on here for long enough... How long does it normally take before people's answers become 'Just use the search facility you ****'?

We seem to have given up on that. approach, since we get the same qeustion every two weeks on average. The assumption now is that if someone can't manage to get the basics under their own steam, we may as well try and help in some way for the practice; it's not like they'll be smart enough to make it as a contractor...

[Hex]

Hi,

My take home pay as an employee under PAYE would seem to be about £4,200

I did the following calculations on a corporation tax/dividend tax instead

Profit - £70,000
Corp Tax (@ 21%) - £14,700
Net Profit - £55,300

Dividend - £55,300
Allowance - £34,800
Taxable dividend - £20,500
Dividend tax (@ 23%) - £4,715

Dividend after tax - £50,585
per month - £4,215

First off, you should use 25% to calculate the dividend tax - not 23%.

Secondly, I think you are probably looking at takehome pay from a Salary of £70,000. This is not a valid comparison. If your company earns £70,000 gross a year and pays it all out PAYE then the salary would be quite a bit less than £70,000, probably more like £60,000 because you also have to pay Employer's NI @ 12.8%.

[Marshall_Clegg]

Thanks for all of the advice, it has helped clarify the basics for me, so that I know where to start looking.

I take on board what has been said about weighing permanent roles against contract. Without going into too much detail, my situation is not as clear cut as it could be, in terms of just selecting a permanent role over a contract role.

I get what you are saying about 70K permanent being more attractive than 70K contract, I was just using the same figures to understand how the basics look financially (to see how the tax compares on a like for like basis).

Thanks again.