The £35k figure is important because that is the threshold for the basic rate of tax at 20%. Anything you earn over £35k will be taxed at 40%.

So, if you earn £50k then on PAYE you'd pay 20% tax on the first £35k and 40% tax on the other £15k.

In a limited company you would pay yourself a salary of say £34,999 to make sure you are a basic rate tax payer. Then, assuming no other costs, your company would have a pre-tax profit of £15,001 (i.e. £50,000 minus £34,999). The company would pay 20% corporation tax at that level of profit. So the £15k profit becomes £12k after tax.

Because you are a basic rate taxpayer, you can then pay yourself a shareholder dividend of the £12k completely tax free.

As an example, a person on £50k on PAYE would have net earnings of around £35k after tax and NI. A limited company on £50k would give you net income of around £38.5k.

But as BG says, you must be very wary of the IR35 rules otherwise you could end up with a substantial bill for back tax.

If you pay yourself the £12,000 dividend in the same fiscal year as you take the £34,999 then you will NOT remain a basic rate taxpayer. The dividend will create a higher rate personal tax liability of £3,000 payable via your self-assessment Return.

Quote Dally="Dally"An umbrella company is not the only way to work in respect of earnings from relationships caught by IR35. You can operate through your own company. "It is quite clear if you fall into one of the IR35 list of employment" - what list is that? There is no specific list. It comes down to the specifics of the relationship between contractor and "client."'" I should have used the word band rather than list, a decent explanation of current IR35 implementation is here www.hmrc.gov.uk/ir35/guidance.pdf IMO there are ways of avoiding the charges an umbrella company make but for the average contractor the benefits outweigh the costs, they will use HMRC best practice advice to keep their clients compliant with tax law without the contractor having to be (or employ) a tax expert. An accountant may be able to save a few quid when compared to an umbrella but that may involve flying closer to the sun than I am comfortable with.

Quote Dally="Dally"An umbrella company is not the only way to work in respect of earnings from relationships caught by IR35. You can operate through your own company. "It is quite clear if you fall into one of the IR35 list of employment" - what list is that? There is no specific list. It comes down to the specifics of the relationship between contractor and "client."'" I should have used the word band rather than list, a decent explanation of current IR35 implementation is here www.hmrc.gov.uk/ir35/guidance.pdf IMO there are ways of avoiding the charges an umbrella company make but for the average contractor the benefits outweigh the costs, they will use HMRC best practice advice to keep their clients compliant with tax law without the contractor having to be (or employ) a tax expert. An accountant may be able to save a few quid when compared to an umbrella but that may involve flying closer to the sun than I am comfortable with.

If you time things right you can have the dividend tax free and then adjust salary for the new year to take into account the income derived from it and get maximum value from your basic rate allowance.

Yes, but if you consistently earn £35,000+ that does not work if you wish to draw all the money out.

Well it might not be on the Vodafone scale of tax avoidance but this is certainly no different from a moral standpoint. More legalised tax avoidance.

This is the quandary i have to be honest. Would this mean I would be better paying myself 35k a year and then leaving the rest of my earnings in the business account or would i then be hammered for other taxes etc.

Sorry if these are obvious questions everyone but its the first time ive had to work like this.

Thanks for all you posts as well everyone!

Wouldn't a limited company also have to pay VAT on the services it provides?



Yup. Just like paying into a pension by salary sacrifice or the various Income Tax allowances and reliefs. There are [iloads[/i of legalised methods of tax avoidance. None of which are any different from a moral standpoint.

Not if it's turnover is less than £77,000 per year. Companies do not have to be VAT registered below that figure.

Most one man band limited companies like this register for vat under the governments flat rate scheme. You can then charge your ustomers 20 percent but only have to pay HMRC 14.5 percent or less.

Again, the only word of warning I'll give to the OP is that you are now walking into the deep end of the swimming pool, you have to be VERY disciplined to run yourself as a Limited Company and when you throw in VAT as well then you are talking about a complete change in your perceptions of how you earn money and how you pay taxes.

If you've arrived at this point from being a PAYE employee for years to suddenly being self employed then stop and think about how you are going to organise the fact that the money that gets paid into your bank account every month is NOT all your money, some of it belongs to HMRC and they get rather shirty when you don't hand it over to them.

Been there, bought the t-shirt, had the t-shirt repossessed

Its a difficult question to answer because everyone's circumstances are different. For example, if you have a wife or partner that doesn't currently work then that is an obvious easy route to get money out of the business tax free. Your best bet is to go and see a good local accountant who will be able to advise you based on your own personal circumstances.