There are 2 ways you can pay yourself as a limited company.
Salary and dividends.
You ask, why bother when as a sole trader you can take money out when you like?
One reason is saving money.[Edit: update at the end].
Firstly, tax is never a reason to become a limited company rather than a sole trader (called incorporating) if there are no other good reasons. Tax can change and it does.
The right time for many freelancers, assuming there were other good reasons as well, was when their sole trader profits were approaching the higher tax rate for income tax.
(Some of my clients were unknowingly already in higher rate tax as sole traders when they contacted me, so I was able to help them save money straight away).
The way you’re paid and taxed as a director of a limited company is different to how you’re paid and taxed as a sole trader. Those differences is what makes part of the decision of when to become a limited company.
There are also other reasons for being a limited company, such as who your clients are (read more here).
As a director of a limited company, you are not allowed to take money out of your business when you like. Legally, your business is separate to you.
You get money out of your business in 2 ways:
1. Salary as a PAYE employee of your own business
2. Dividends as a share holder of your business
I’m not going to go into details of how this works, the rules and what you need to do, you can read more here.
This meant that according to current tax rules, your business could be structured so you paid less tax as a limited company director than you would as a sole trader if your profits were over £40k (ish). Once your profits were £35k+ it was time to look into changing to a limited company.
Tax works differently.
The company pays corporation tax on its profits for tax and Class 1 employer National Insurance if appropriate.
You (as a person) may – or may not – pay Class 1 employee National Insurance, income tax on your salary and tax on your dividends.
In practice, it’s easy to structure your company so you pay a lot less tax overall, as if you’re a one person limited company, you are your company even if you’re legally separate.
There are other ways of saving money/making your money work harder as a limited company (maternity pay, pension contributions, sick pay etc).
What is changing is how dividends are taxed.
Dividends are money you are paid for being a shareholder in a company. They must come from a businesses post tax profits. They can be dividends in your company, or someone else’s.
(I’m not writing about dividends in other companies you may have shares in, but these changes affect those also).
Previously dividends had this fiendishly complicated system of ‘credits’ which meant in practice you paid less tax – and was also a hamster’s sweaty armpit of complication to explain or work out. Suffice to say, unless you earned 6 figures, you ended up not paying tax on your dividends as a general rule.
The government announced in July 2015 it is simplifying how dividends are taxed. They haven’t specified how yet. (Handy huh?)
In case you missed that, the government announced they are dramatically changing the tax for how millions of one man band limited companies pay themselves most of their money.
The government say they are doing this by April 2016 (that’s 8 months time as of July 2015).
The government haven’t given any details yet.
Which brings me to…
The government has clarified the situation although it’s still not crystal clear and you may need to get out your calculator and the red wine.