Sole Trader or Limited Company?

Sole trader or Limited company?

When it comes to setting up your business you need to think about how you want to trade. The most common question is "Should I be a sole trader or limited company?" The most straightforward answer relates to how the different setups are taxed but there is more to it as we consider here.

Sole Trader

Advantages

Easy to set up.

Simpler for tax and accounts purposes (See below).

Control - You are the business and so have complete control of what happens (or doesn’t!) You can make decisions quickly.

It’s all about you! - As you reputation grows people get to know you and how good you are.

 

Sole Trader

Disadvantages

You take sole responsibility of running the business

Unlimited liability - you are liable for all the expenses and debts of the business

Finance - Can be harder to raise funds as its down to your credit history etc

It’s all about you - As you reputation grows , if it doesn't go so well, it's your name.

You appear as a smaller business

 

Taxation

As a sole trader you are taxed on the profit you make from your business. That is, you deduct any business expenses you have from any income you have made and what’s left is your profit. 

In addition to this , depending on your net profit you may be liable for Class 2 and Class 4 national insurance contributions. 

Sole Traders complete a Self Assessment Tax return each year and your profits from self employment is added to the rest of your income (e.g employment, savings, investments, property) to assess how much tax you have to pay.

 

Limited Company

A limited company is a separate legal entity. The owners are the shareholders and the people charged with day to day management of the business are Directors. If you are working on your own you will be the shareholder and Director. 

As the limited company is a separate legal entity you have certain responsibilities as a director such as: 

The shareholders are entitled to a share of the profits via payment of dividends. They also have limited liability to the amour of money that have put into the business. So if the company takes out a loan in it’s name, and cannot pay it back you are not liable.

Limited Company

Advantages

Limited Liability - Shareholders are only liable for the amount of money they put in

Separate Entity, company is separate from its owners and carries on regardless which gives security to employees etc

Taxation Advantages - see below

Limited Company

Disadvantages

Extra Accounting and reporting Requirements

Costs - Extra reporting means extra costs

Can be difficult to raise funds - A new limited company has no track records and therefore lenders may be reluctant

Taxation

Taxation of a limited company is more complex than a sole trader but offers more opportunities for tax planning in that if you are the owner and the director, you can decide how and when you are paid using a combination of salary and dividends. 

A limited company will pay corporation tax on the profits it makes and this is due 9 months and 1 day after the end of it’s accounting period. 

As a shareholder you are liable to income tax on any dividends that you are paid by the company. Some of these dividends are tax free and you then you pay income tax at 7.5% if you are a basic rate tax payer. There is no national insurance to pay on dividend income.

With careful tax planning, depending on profits, you can often reduce the overall amount of tax you pay as an owner manager.

 

So which is best - sole trader or limited company?

It is very easy to say be a limited company with the tax planning opportunities and limited liability that this that this route offers, however there is much more to it than that. For example, a limited company is more expensive to run, can be less flexible and so all of this needs to be taken into account when you chose the best structure.

If your business is relatively small you may wish to consider started out trading as a sole trader and  once the business starts to grow look at the other business models available. You can change between the structures but need to be careful about tax and legal issues.

In some cases the decision is very simple and many businesses that are started from home start out very small with a limited budget and therefore operating as a sole trader is the most effective way, for others, with large plans or starting off a bit bigger a limited company is the best way forward.

In all cases it is worth talking to an accountant who will be able to give you the right advice from the outset and make sure you get what is right for you.

Summary

Here are some things to consider when making your decision:

  • Image. Having a company might suggest that your business is bigger than it is and more well established, you might feel that people will take you more seriously if you trade through a company rather than as an individual.
  • Limited liability. As a sole trader or self employed person, you are your business. If you borrow money for work, then it is you personally that owes that money, so if it all goes wrong then you are liable for the businesses debts or you could be sued for problems such as breach of contract. Setting up a company reduces this risk as a company is a separate legal entity, so if the company owes money and can’t repay it, you don’t have to dig into your own pockets. There are a few caveats to this, though – for instance, if you have acted negligently or fraudulently then this won’t be the case.
  • Tax savings. A self employed person pays tax and national insurance. A limited company only pays corporation tax. Therefore you can reduce your overall tax bill by setting up a company. However, the reporting requirements are greater for a company, meaning that there is more red tape for you and greater accountancy bills. We usually find that if you are making a profit of around £25,000 per year or more, you will save overall by using a company, but individual circumstances need to be considered.
  • Financial flexibility. A company can be flexible in that other people can own shares in it (and so receive dividends, their share of the profit) and you can decide when to take money out of the company. If you are likely to be earning more money than your partner, both owning shares in your company can be a good way to reduce your overall tax bill

A common misconception is that companies have to be registered for VAT, but that isn’t the case. You need to register for VAT if your relevant turnover is over a threshold – currently £85,000 – regardless of whether you are a sole trader or limited company.

If you decide to set up a company, you will need to choose a name for it that has not already be used by another company. You then need to get it registered with Companies House.

Speaking to an accountant before getting set up, or changing your business structure can help you to be sure you make the right decision – Get in touch to book a FREE consultation and we can talk to you about how this applies to you and your options.