A popular topic in the Advanced Tax and BPT exams is offering advice on the difference between setting up a sole trader and a company making profits of £50,000.

A sole trader business is part of the same individual’s income. If you are a higher rate taxpayer, then the profits will be subject to income tax at 40% and Class 4 NIC at 2%. There will also be small Class 2 NIC liability of £159 a year.

This means that the after-tax income will be £50,000 x 58%= £29,000 -159= £28,841.

Alternatively, if you set up a company, it is a separate legal entity and subject to corporation tax at 19%. Assuming that the profits are extracted via a salary of £45,000, the company will have pay employer’s NIC on the salary at 13.8%. The company can claim an employment allowance of £4,000 to reduce the liability.

(45,000- 8,788) x 13.8% = 4,997-4,000= £997

The salary and the employer’s NIC liability will be an allowable expense in computing taxable profits.

The taxable profits of the company are (50,000-45,000-997) = 4,003 will be subject to corporation tax at 19% resulting in a liability of £761.

The total tax liabilities paid by the company are £997 + £761= £1,758.

The £45,000 salary is then subject to income tax and Class 1 Employee NIC at 42%. The after-tax income is £45,000 x 58% = £26,100.

From the £26,100 we then deduct the tax liabilities paid by the company (26,100- 1,758= £24,342).