According to new research released in a Small Business Tax Action Report, freelancers and small businesses could be wasting up to £4.2 billion by not considering a change in their business structure from sole trader to limited company.
The report, which is produced by Unbiased, reveals that around 1 million sole traders and 246,000 partnerships could potentially benefit from forming a limited company for their business. In doing so small firms could save billions in national insurance payments on their profits.
The annual Tax Action Report looks at the average amount of tax wasted as a nation. This year for the first time the report includes a section that looks at the key areas of tax wastage amongst SMEs. The Small Business Tax Action Report examines the savings SMEs could make by changing business structure and making better use of allowances, tax credits and tax efficient business support schemes.
The report highlights that many SMEs are currently not maximising tax efficient methods of running a business and there is a whopping overall tax wastage of £7.1 billion by SMEs in the UK. This works out at an average of just over £1,500 for each of the 4.5 million small to medium sized businesses that operate in the UK.
One significant saving could be achieved by incorporating a business and taking a lower salary up to the threshold at which National Insurance is payable, then taking the balance of post-tax profits as dividends, which are taxed at a lower rate. Currently when owners of an unincorporated small business have earnings that reach a certain threshold they are required to pay national insurance contributions as a percentage of the business’s annual taxable profits.
Karen Barrett, chief executive of Unbiased said:
“Tax is a vast and complex subject and business owners often simply do not have the time to understand how to optimise their tax status whilst also running their business day to day. Our Small Business Tax Action Report reveals that by not considering incorporation, small businesses could be missing out on huge National Insurance savings. Whilst this option will not suit all businesses, it can be an effective way to save money and it’s well worth considering by businesses that meet the criteria.”
Of course, before deciding to incorporate you should decide whether this is the right move for your business. If your profits do exceed the basic rate tax band it is something you should consider in order to save on income tax and national insurance contributions.
If you need more information about the advantages and disadvantages of forming a limited company, see our rundown of Limited Company vs Sole Trader.