Your business structure can significantly impact how you are taxed as a business owner.
As I began chatting with one of my clients, he shared some great news with me. He wanted to start a business. This was very exciting, and I was excited listening to his idea and dream and how it would come to fruition. It’s an essential part of my role as an advisor to make sure my clients can trust me and that they know I am in their corner from start to finish.
Once we chatted about how this business would manifest, we started discussing the reality of making that happen. My client was candid and admitted to having no idea about starting a business and what it would mean for his tax situation.
Leaving aside the fact this client is a US citizen, it occurred to me, as a business owner myself, that it’s a terrifying thing to begin your own business as you suddenly realise there is so much you don’t know and have to figure out, especially taxes. No wonder many would feel intimidated to begin their own business or never get past the planning stage after focusing on all the unknowns.
I’m writing this to share some insight on how you can be tax efficient from the outset without being a tax expert, and that is by choosing your business structure.
Business Structure
Choosing your business structure can impact your income taxes from the start, especially if you decide to stay employed while you build your business. Know that in tax, nothing is set in stone; as the rules change from year to year, so will your business.
Sole Trader
A sole trader or a self-employed individual is the most straightforward structure a business owner can form. It takes little administration except registering with HMRC and an annual tax return each year. Keeping records is essential as HMRC may ask you to provide evidence of your business deductions. Sole traders are taxed at graduated income tax rates and subject to pay Class 2 and 4 National insurance contributions with their self-assessment by the due date each year.
Partnership
This would be very similar to a sole trader, except more than one person owns and operates the trade alongside you. A partnership return is due by the self-assessment due date, but the partnership does not pay the income tax and national insurance. The partners pay tax and national insurance on their share of the profits. Partners should file their self-assessment and pay tax by the regular due date.
Corporations
Incorporating may seem like the best option because the corporation tax rates are generally much lower than the income tax rates. However, there is much more compliance and administration to consider, and any income made by the company belongs to the company, not the owners. Extracting the payment in the most tax-efficient way can need special attention. A corporation does not receive a personal allowance. So all the profits will be subject to corporation tax, unlike the sole trader and partners who still receive their personal allowance before tax is applied.
VAT
Typically a business is not required to register for VAT until they reach £85,000 in revenue, and then the registration is compulsory. Nevertheless, this may not be the most beneficial to all businesses, and some may find it helpful to register voluntarily. There are many variables to consider in this decision, such as whether you are selling B2B or B2C, making and selling taxable goods or services, and where the end buyer is located. Business owners may also note that it can raise the profile and credibility of a business to register for VAT voluntarily.
The best advice I can give to anyone who wishes to start a business is to do it! There is so much to learn and discover that you shouldn’t let something like not understanding tax stop you. When deciding on a business structure, you may want to keep it simple, so a sole trader is the best option. If you want protection from claims with limited liability, then incorporate. If your trade typically expects a VAT registration, then voluntarily registering may benefit your business brand and credibility. If this makes you feel apprehensive, you may want to seek advice.
The point of this article is not to lure you into paying for services that you may or may not need, but rather, it is a way to cut through the complex tax system and empower you as a business owner to make the most tax-efficient decisions for you and your business.
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