sole trader or limited company – what’s the right choice for you?

Sole trader or limited company

Sole trader or limited company? When starting a business one of the first important decisions to make is whether you want your business to operate as a sole trader or limited company. Both of which have their own distinct advantages and disadvantages and in order to decide which is more suitable for your business you first need to understand what the differences are between the two. This article is designed to help you learn the differences between limited company v sole trader so you are better equipped to decide which is right for you.

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What is a sole trader?

A sole trader is a self employed individual who runs their own business. Operating as a sole trader is considered by most to be the simplest form a business can take. The key characteristic of being a sole trader is that the business and the individual operating the business are (from a legal standpoint) viewed as the same person and this means that any profit made by the business belongs to the individual but likewise so does any debt and any legal responsibilities. 

If you decide to operate as a sole trader then you’ll need to keep detailed records of all business income and expenses for at least 5 years following the 31 January submission deadline of the relevant tax year. You can either trade using your own name or you can choose a suitable “trading name” that needs to be displayed on any invoices/receipts along with other business details. There are also certain guidelines  to follow when choosing a name for your new sole trader business.

To register your business as a sole trader the process is relatively simple, you’ll just need to register for self assessment via the HMRC website and submit an annual tax return detailing any profits or losses your sole trader business makes. There are strict rules surrounding which expenses are allowable for a sole trader business so it’s important that you speak to an accountant where necessary as they will help you to operate as efficiently as possible and ensure you avoid incurring any penalties from HMRC. They will also be able to answer any questions you have about setting up as a sole trader or limited company.

Advantages of being a sole trader

– Setting your business up as a sole trader is very straightforward and the administrative responsibilities are less than those of a limited company. This is because you’ll only be required to report financial information to HMRC via an annual self assessment whereas the limited company needs to report to both HMRC and companies house.

– If you operate your business as a sole trader then there is no requirement to file any information with companies house which is a public record. This means that both business finances and your personal information are kept private.

– If you ever need to close your business down the process of ceasing your sole-trader business is quick and low cost.

Disadvantages of being a sole trader

– As a sole trader the business and the person who operates it are legally considered the same person which means if the business is subject to any legal claims against it or incurs debt then the individual is personally liable. In a worst case scenario this means personal assets could be used to repay outstanding business debts.

– Any profits generated by a sole trader business are considered earnings of the individual who runs it and must be recognised for tax purposes in the tax year they are earned. This leaves very little room for any effective tax planning as you cannot delay earnings to utilise more beneficial rates or renewed allowances.

– When operating as a sole trader you will need to pay income tax on any profits that the business generates  which currently varies between  20-45%. You’ll also need to pay class 4 national insurance at a rate of 9% or 2% depending on the amount of profit and subject to personal allowances and relevant thresholds. The combination of these two taxes often leaves the sole trader with a larger tax bill than a limited company. 

– sole traders who’s profits exceed £6475 per year also need to pay class 2 national insurance at a cost of £3.05 per week.

What is a limited company?

A limited company is considered a separate legal entity from the people or person who runs it and as such the finances of the business are treated as separate from the finances of the individuals. The limited company will have its own registered office, its own bank account and will even build its own credit score over time.

 A limited company is owned by it’s shareholders but the day to day running of the business is done by the directors. The company can have as many directors and shareholders as it needs but many small businesses that are run by an individual set themselves up as the sole director and sole shareholder, this way they have full control of the company and are entitled to 100% of the profits distributed from it.

 If you operate your business as a limited company you’ll need to keep detailed accounting records for at least 6  years (sometimes longer) following the end of the financial period they relate to. When choosing a name for your limited company there are certain rules that need to be followed, for example you cannot choose a name that already exists and you must include the word limited or ltd in the name. Full details on naming your limited company  can be found on the HMRC website:

To register your business as a limited company you’ll first need to form the company via a company formation agent who will provide you with a certificate of incorporation along with all the necessary documents that support your new company. Once formed the company needs to be registered with both companies house and HMRC, both of which have annual filing requirements to consider

Advantages of a limited company

As the company is considered a separate legal entity from the individuals who run it, the shareholders and directors are not personally liable for any debts, losses or legal claims made against the company. In this respect the individuals personal assets are protected and in a worst case scenario they only stand to lose the money they initially invested.

– Any profits generated by the limited company are first subjected to corporation tax (which is currently a rate of 19%) but can then be distributed to shareholders as and when the directors see fit in the form of dividends. This increased flexibility opens the door to clever tax planning. A sole director/shareholder will usually pay themselves a small salary topped up with dividends for maximum tax efficiency. This can result in the individual incurring a lower tax liability than had they been operating as a sole trader.

– There is a certain status that comes with operating as a limited company. customers, banks and the general public often view limited companies in higher regard than their sole trader counterparts and there are certain industries that choose to do business exclusively with limited companies.

– Certain additional expenses are able to be offset against income via a limited company which can help to reduce the tax burden. Examples of these include director subsistence and pension contributions.

Disadvantages of a limited company

– There are increased filing requirements for a limited company as they must report to both HMRC and companies house.

– Financial statements submitted to HMRC and companies house need to be prepared in accordance with certain accounting standards. The preparation of these accounts is usually undertaken by a qualified accountant.

– Both information on the companies finances and personal details of directors need to be submitted to companies house and are held on public record for anyone to access which results in reduced privacy.

– When you are finished with the company there is a more formal process to close it down which can be more time consuming and costly.

Sole trader or Limited company - Can i change my mind at a later date?

Yes, it is possible to switch your business from a sole trader or limited company setup to the alternative however the process can be a little time consuming and costly. In addition to this if you were to choose a setup that is less tax efficient for your personal circumstances then you will spend a period of time missing out on those tax savings. It is much easier to take your time, seek professional advice and make the right decision from the start when deciding between sole trader or limited company.

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So which is best for me, sole trader or limited company?

Although all of the above should be considered when deciding between sole trader or limited company, it’s usually tax efficiency that bares the greatest influence. A limited company is considered by most professionals to be the more tax efficient option as the opportunities for tax planning are far greater however there are many other factors such as anticipated profits, other income and personal circumstances that will determine exactly how effective each option is.

Because everyone’s own story is unique it is very important to speak to a professional who can ensure you make the right decision.

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