When you’re new to running a business (and even if you’ve been doing it for a while!), tax can be confusing. Rather boringly, there’s never really a way of avoiding tax. Any money that you earn for yourself through your business will be taxed somehow. The only question is how.
Tax works differently depending on the way that you pay yourself from your business, and this depends on the type of business you have. The four main types of business are sole traders, ordinary partnerships, limited liability partnerships and limited companies.
Just don’t forget that businesses pay tax on profit, not on income! So make sure you record all of those allowable expenses.
How do sole traders pay tax on their income?
One of the most common types of business in the UK is the sole proprietorship (run by sole traders). Sole traders aren’t legally separate from their business, so in terms of paying themselves it’s pretty straightforward.
You won’t need to pay yourself a salary from the business, and instead you simply keep the profits for yourself. The downside of this is that you will pay tax on these profits whether or not you actually take them from the business.
Sole traders make Self Assessment submissions to tell HMRC about this money, and to pay the right amount of tax on it.
Some advice for sole traders paying tax
If you are a sole trader, remember to save some of the money the business earns so that you can pay the tax that will be due!
It’s also a very good idea to set up a different bank account for your business transactions, separate to your personal account. It makes it much easier to keep track of everything in your bookkeeping.
How do I pay tax if I’m in a partnership or an LLP?
There are two main types of partnership in the UK – general partnerships, and Limited Liability Partnerships (LLPs). Although these are slightly different in terms of liability, they deal with tax in pretty much the same way.
The business will submit a tax return, but it doesn’t actually pay tax as an entity. Instead, HMRC ‘look through’ the organisation to the partners. As a partner, you’ll submit tax returns still make Self Assessment submissions to tell HMRC about your share of the money that the partnership makes, and you’ll pay tax independently of the other partners too.
Paying tax when you own a limited company
The owner of a limited company is legally separate from their company, so you can’t just take profits that the business earns in the same way as a sole trader or partner can. Instead, someone with a limited company can:
- Make themselves a shareholder, and then take dividends
- Appoint themselves as a director, and take a salary
Most people who run a limited company decide to do a combination of the two, because it’s more tax efficient that way. It’s important to get to the balance right though, because taking a salary from the business means that you’re both an employee, and an employer.
Employees and employers both pay National Insurance on income above the NI threshold, which is why most directors take a salary at the threshold, so they don’t incur two lots of NI.
So what about actually paying the tax? Well:
- The company will submit a Company Tax Return, and pay Corporation Tax on its profits
- If you pay yourself dividends from the profits, you’ll need to make Self Assessment submissions, and pay dividend tax on them
- If you take a salary from the company then, as your employer, the company will deduct any NI and tax that it needs to, and pay this on to HMRC on your behalf
What else do I need to consider?
It’s also worth noting that there might be other factor which affect your tax. For example, if you have another source of income and you don’t pay tax on it at source (like you do on the wages you earn from an employer), then you’ll need to report this through Self Assessment too.
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