Additional earnings through a Company or sole trader?

What is the ideal legal structure for your business

I'm about to outline a nice personal finance problem and am interested to know reader opinions so please feel free to write them in the comments below. Also tweet me @millionairer0ad if you want to chat/ have a debate.

The personal finance problem

So the issue is this: you've been working hard at a side project or a selection of side gigs and it has started to earn some cash. You're now pulling in an additional £500 per month from your side gigs. How should you structure your taxes in order to minimise your tax liability?

What are the options?

For this personal finance issue there are only two feasible options:

One option is to earn the money each month, set it aside in a bank account and at the end of the tax year you will fill out a tax self assessment form and pay the additional income tax as a sole trader. The problem with this approach is that if you're a higher rate tax payer you get clobbered with a 40% marginal tax rate so you only actually earn 60pence in every £1 earned from your side projects.

The alternative option is to set up a limited Conpany with all the shares owned by you. At the end of the year you will pay corporation tax on your profits at a marginal rate of 20%. As a result you keep 80pence in every £1 earned from your side businesses and can reinvest. The issue is that if you want to actually access the cash for purchases or personal investments then you will get clobbered once again by your marginal tax rate whether you take the cash out of the Company as a dividend or as income.

What's the solution?

Like most great answers there isn't an ideal solution. The true answer is that it all depends. At the end of the day the income has to be taxed at some point. However the Company option makes more sense in the following circumstances.

If your side businesses incurs lots of expenses, you may wish to use the Company structure. This will allow you to offset your expenses against your profits, minimising the profits but also minimising the tax liability. A Company may also be a better structure of you have no immediate use for the cash generated by your side businesses. It may make more sense to keep the money in the business as a Company and reinvest, accelerating the growth in future profits. This means that when you are eventually taxed when taking the cash out of the business at least the profits will be substantially higher than when you simply paid tax each year as a sole trader.

The converse to this is that if your side business is pretty simple in structure and have very few costs but generates lots of income then you might as well pay tax as a sole trader and simply fill out your self assessment form.

Readers, are there any pros or cons to Company versus sole trader for additional income earned from side gigs that I haven't considered? Drop me a line on twitter @millionairer0ad or put a note in the comments.

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