Personal income tax vs corporate income tax is the distinction we need to make if we speak about income taxes.
So, you have personal income tax on the one hand and corporate income tax on the other hand. The application of each of them differs depending on your situation.
Their respective names already suggest what we are talking about…
Personal income tax
Personal income tax refer to the income taxes you pay on your income as a natural person – private individual.
This is, for example, the case if you receive a wage from your employer or if you make a the profit as a sole trader.
Also income from investment or real estate will be taxed in most countries. However, sometimes different rates apply compared to professional income.
Most Western (European) countries apply progressive tax rates. This means that the higher your income, the higher your tax rate (e.g. Germany). However, there are also countries out there who do apply a fixed tax rate (e.g. Bulgaria).
These progressive income tax rates will apply to your professional income.
For employees, this is basically the wage they receive from their employer.
For freelancers / sole traders, the tax is generally spoken calculated on your profit. You obtain your profit by deducting your expenses from your revenue. However, some expenses might not be taken into account as a deduction or only taken into account partially. This could be the case if they don’t have a direct link with your profession.
Some countries (e.g. Czech Republic) also allow you a lump sum deduction without the need to actually provide proof of your expenses.
Social contributions
A lot of times when people look for countries with low tax rates, they miss something very important. The thing they are missing is social contributions.
Apart from income taxes, you will also pay social contributions on your professional income. In some countries, the rates of social contributions are even higher than the income tax rates.
Therefore, it is important to always have a good understanding of the full picture: look at your overall tax burden, including your social contributions.
Corporate income tax
On the other end of the spectrum we have the corporate income tax. As the name suggest, this tax applies to corporates or legal entities.
Unlike for personal income taxes, most countries do have a fixed rate for corporate taxes. What some countries do have is a discounted rate for a certain limited amount of profit depending on some conditions.
The corporate tax rate will be applied to your taxable basis. You will calculate your taxable basis by deducting your expenses from your revenue. Some expenses might be disregarded partially or in full depending on local regulation.
If you pay yourself a wage from your company, you will also be able to deduct this as an expense. At the same time, you will of course need to pay personal income taxes and social contributions on this wage.
Once you paid your corporate income tax, you end up with your profit after tax.
In order to be able to spend this money yourself, you still need to get in your private bank account first. This you do by paying out a dividend distribution.
In most countries, you will need to pay a withholding tax on this dividend distribution. The final taxation will depend on your personal tax situation.
Conclusion: personal income tax vs corporate income tax
Understanding the difference between personal income tax vs corporate income tax is important. Definitely if you are looking at your tax setup as a digital nomad.
You should assess what works best for your situation. You can receive income in your personal name or through a company.
In the first case, you will need to take into account personal income tax and social contributions.
If you opt for a corporation, you need to look at corporate income tax and withholding tax.
Reach out if you want to assess your tax setup with a professional tax advisor.
