Limited Company Vs Sole Trader – Understanding the Tax

1. You may or may not have heard the stories in the media about other countries complaining about Ireland’s ‘unfair’ tax rate. In case you didn’t know, they are referring to the Corporation Tax rate in Ireland which at 12.5% is considerably lower than most countries. For example Belgium’s rate is 25%, Austria’s is 25%, Greece’s is 24%, the UK’s is 25%.
2. The 12.5% rate is, understandably, a considerable factor in many Irish business owners’ decision to incorporate their business.
3. So, in simple terms, a Limited Company pays Corporation Tax on its’ Taxable Profits; a Sole Trader pays Income Tax on the Taxable Profits of his/her business.
4. There are 2 Income Tax Rates: 20% & 40%. A single person will start paying Income Tax @ 40% once Taxable Profits hit €35,300 (2021 figures). They will also pay PRSI @ 4% and USC (the highest rate is 11% for Taxable Profits over €100,000).
5. Essentially the highest possible rate (the marginal rate) of Income Tax is a combined rate of 55%. (Adding Tax, PRSI & USC together).
6. It would be misleading of me not to point out that in reality most Sole Traders do not pay Income Tax at this rate. The actual ‘effective’ rate of Income Tax is usually lower, but it is dependent on individual circumstances.
7. But a Sole Trader running a successful business with Taxable Profits of €100,000 or more will pay Income Tax at an effective rate of 55%.
8. It is crucial to point out at this stage that the after-tax profits of a Limited Company remain within the company, and that in order for the owners (Shareholders and/or Company Directors) to extract an income from the business, they will have to deal with another layer of taxation.
9. BUT a significant advantage of operating a Limited Company is that there is greater flexibility in
10. Arriving at the Taxable Profits of the business and
11. Extracting an income from the business.

In Summary:

1. The decision to set up a business as a Sole Trader or a Limited Company should involve an analysis of the tax implications of each scenario.
2. On the face of it the Corporation Tax rate of 12.5% would suggest that every business should set up as a limited company BUT in reality it is not that simple.
3. Consideration needs to be given to several factors, and every business owners’ circumstances are different.
4. The ultimate objective of all this decision-making is to increase the business owners’ after-tax take home pay.