Why you might pay more tax using a limited company

simon

Simon Misiewicz

30th June 2020

Article relevant to 2020/21

Why do people use a limited company?

You may be interested in our main article “buy to let tax for UK landlords”. This article discusses all the different types of tax that you need to be aware of as a UK landlord. You may also be interested in reasons why people should and should not use a limited company to buy a property.

Why UK landlords might pay more tax using a limited company 

UK Landlords may look at their current situations and decide to use a limited company because they will save tax. The same buy to let investors need to think about the long term. A property investor may have a good job and a high rate taxpayer. It may be their goal to become financially independent and rely on their property income to satisfy their lifestyle needs.

Once they achieved a certain level of income, they might decide to give up their job. They now need to pull on the money that has been earned in their limited company. As such, there is a now a double taxation issue. The company will pay corporation tax at 19%. The person receiving the dividends (as an example) would pay 7.5% income tax if they were a basic rate taxpayer. This income tax would increase to 32.5% income tax if they were a high rate taxpayer. Finally, an increase in the income tax rate of 38.1% would be suffered by additional rate taxpayers.

People that need all the money from a limited company will pay more tax.

Anyone that requires all the money from the limited company would pay more tax than if they had the income in their own personal name.

We will show this by way of an example. James has £25,000 of income.

£25,000 income

(£12,500) personal allowance where no tax is paid

£12,500 taxable

£2,500 income tax at 20%

 

If the person had all the income in a limited company the following would apply

£25,000 income in the limited company

£8,000 wages (tax-efficient to extract without income tax or NI)

£17,000 in profit

£3,230 corporation tax at 19%

 

James will now extract the remaining £13,770 in the form of dividends

£8,000 wages paid to him free from income tax and NI

£4,500 Dividends paid to him tax-free

£12,500 personal allowance with no tax to pay

£2,000 additional dividends to be taken tax-free

£14,500 tax-free money from a limited company

 

We now need to work out what dividends is subject to income tax

£13,770 dividends extracted from the company

£6,500 dividends taken out of the limited company tax-free

£7,270 dividends subject to 7.5% income tax rate

 

£3,230 corporation tax paid

£509 income tax in the dividends

£3,739 total tax paid

 

I am hopefully hat you can see that James would pay more tax if he extracted the money from his limited company. This would worsen once he became a high rate taxpayer and started to pay 32.5% income tax on the dividends extracted.

 

Why property investors may be less profitable using a limited company

A buy to let property that requires a mortgage will pay interest. The interest rate applied to individuals tends to be less than it does to limited companies. As such, there are additional interest costs in a limited company that reduces its profitability.

A limited company also has additional costs of it being run. An accountant will be required to file annual company accounts to Companies House and tax returns to HMRC.

All these additional costs lead to less profitability.

Download your buy to let tax guide here, written by our property accountants

Buy multiple properties form the same vendor to claim multiple dwellings relief to reduce Stamp Duty Land Tax

Lose tax reliefs when using a limited company 

There are many tax reliefs that individuals benefit from. Examples are:

– £12,500 personal allowance (tax-free earnings)

– £12,300 Capital Gains Tax annual allowance

In addition, anyone that sells their home that has been lived in as their sole private residence will not have to pay Capital Gains Tax.

A limited company does not have a tax free element at all. Any profits made in the limited company will be subject to 19% corporation tax.

If you want to know more, then please read our “buy to let tax tips for UK landlords” article.

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