Historically, if you run a reasonably profitable unincorporated business, it made financial sense to incorporate as a company to secure tasty income tax plus national insurance savings. By paying yourself a modest salary and extracting remaining profits as dividends, owner-managers could reduce personal tax bills thanks to the old dividend regime. But with the recent tightening of dividend tax relief, have the benefits of switching corporate structure fizzled out?

How Dividend Taxation Changed

Up until April 2016, all dividends included a 10% notional tax credit, reflecting that pay-outs aren't deductible expenses for corporation tax. This mechanism meant basic-rate taxpayers had no extra dividend tax to pay, while higher and top-rate taxpayers still enjoyed lower dividend rates versus normal income.

Yet from 2016, this cushy regime crumbled. The tax credit disappeared, replaced with a £5,000 dividend allowance that has since shrivelled to £1,000. More painfully, dividend tax rates then increased for higher and additional rate taxpayers. An extra 1.25% health and social care levy from 2022 has further inflated rates.

Scrimped Allowances, Swelled Taxes

To demonstrate the impact, let's compare a sole trader to a one-person company for 2022/23 and 2023/24, assuming £60,000 profits. In 2022/23, the company saves circa £3,000 tax versus sole trading. But in 2023/24, the savings dwindle to £2,250 due to the corporation tax hike. At £100,000 profits, the savings also shrivel from £1,800 to £150. And at £300,000 profits, the sole trader pays £3,250 less tax than the company director! Ouch!

Silver Lining for Smaller Profits?

However, the outlook isn't completely dire for lower-profit businesses in 2023/24. Limited Companies retaining under £50,000 profit still enjoy the 19% small profits corporation tax rate, while marginal relief cuts the effective tax rate to 26.5% for profits from £50,000 to £250,000.

For instance, a company making £40,000 profit could save an owner-manager around £7,500 tax versus sole trading. Even at £100,000 profits, incorporation potentially saves circa £15,000. For more compact outfits, adopting a company structure can, therefore, still unlock useful tax savings this year.

Future Upheaval?

Given the rocketing national debt, whether the existing regime will persist in the long term seems uncertain. Further stealthy dividends, salary or corporation tax grabs appear plausible to fill Treasury coffers. So before incorporating, wise unincorporated businesses should model future profit scenarios and projected tax liabilities as best they can.

If you can reliably forecast eternal profits under £50,000, becoming a company still makes sound financial sense, thanks to the lower corporation tax rate. But for incomes approaching £200,000, expect savings to dwindle rapidly courtesy of the latest tax changes.