Self-Employed or Limited Company? When Incorporating Really Pays Off

One of the questions that comes up most often at any accounting firm is whether it makes more sense to stay self-employed or set up a limited company (SL). A popular rule of thumb goes: “once you reach €40,000 in profit, an SL pays off.” It is a dangerous oversimplification. The right answer depends on how much money you need to take out of the business to live on, not just on how much you earn.

Personal income tax vs. corporate tax: the real tax comparison

A self-employed person pays personal income tax (IRPF) on a progressive scale: the more they earn, the higher the percentage paid on each additional bracket. All of the business’s profit is added to their taxable income, whether they withdraw it or not, because the individual and the business are one and the same.

A company, by contrast, is a separate taxpayer. It pays corporate tax (Impuesto sobre Sociedades, IS) on its profit, at a general rate of around 25 %, with reduced rates for micro-enterprises and newly created entities, whose application you should check against current legislation. That rate is flat rather than progressive, which is why on higher profits it is usually lower than the marginal personal income tax rate.

But that is not the end of the story. The money left in the SL is not yours until you take it out, and there are two ways to do so:

• Salary as a director or employee: it is a deductible expense for the company, is taxed as personal income in your own tax return, and carries Social Security contributions.
• Dividends: they are paid out of profit that has already been taxed under corporate tax, and are taxed again in your personal return as savings income.

In other words, if you need all the money to live on, you will end up paying corporate tax plus personal income tax on the part you distribute as dividends, or personal income tax and contributions on the part you draw as salary. The tax saving from an SL appears mainly when part of the profit stays inside the company, to reinvest, to grow, or simply because you don’t spend it.

A rough example with round numbers: a professional with €60,000 in profit who needs €40,000 to live on can leave €20,000 in the company, paying tax on it at the corporate rate only. If they need the full €60,000, the advantage shrinks considerably or disappears, and the costs of running a company weigh more heavily.

The hidden costs of an SL that almost nobody mentions

When comparing, many people look only at tax rates and forget everything else a company adds. Before deciding, add up:

• Incorporation: notary, commercial registry and initial paperwork.
• Mandatory bookkeeping: an SL must keep accounts in accordance with the Commercial Code and the General Accounting Plan, which normally means higher accounting fees than a self-employed person’s direct estimation regime.
• Annual obligations: preparing and approving the annual accounts, filing them with the Commercial Registry, and submitting the corporate tax return.
• Director’s contributions: if you hold effective control of the company, you will usually have to pay contributions under the self-employed scheme even though you are paid by the SL, with amounts calculated according to your earnings.
• Liability: an SL limits personal liability, but in practice banks and suppliers often ask the partners for personal guarantees.
• Rigidity: taking money out without justification (partner loans, personal expenses) creates tax and corporate-law problems that a self-employed person doesn’t face.

These costs are fixed or nearly fixed, so they weigh heavily on low profits and lightly on high ones. That is why the break-even point is not a magic number.

The €40,000 myth and when it really pays off

There is no legal or universal threshold. €40,000 works as a rough reference, but two people with the same profit can end up with opposite results. An SL tends to pay off when several of these circumstances apply:

• Profit is comfortable and you don’t need to withdraw all of it to live on.
• You plan to reinvest in the business: staff, equipment, expansion.
• There is a significant risk to your personal assets in the activity.
• You want partners, outside financing, or a structure that makes a future sale easier.
• You will mainly invoice companies that prefer to contract with a limited company.

Conversely, if your profit is moderate and you spend almost all of it, moving to an SL usually means adding bureaucracy and cost to save little or nothing. It is common for a self-employed person with €40,000 in profit who spends €38,000 a year to pay more in total as a company.

A sensible approach is to simulate both scenarios with your real figures: expected profit, personal income needs, contributions, accounting fees and investment plans. With that comparison in hand, the decision stops being a gut feeling. And remember that converting from self-employed to a company also has implications for the transfer of assets and the continuity of the business that should be reviewed before making a move.

At Zythos Business we do exactly that exercise with every self-employed professional and small business that asks us: we put real numbers on the table, compare scenarios, and tell you clearly whether the move pays off, when to make it, and how to handle the company’s bookkeeping and taxes afterwards without surprises.